1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 1 TO FORM 10-K/A (MARK ONE) [X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JULY 3, 1998 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NO. 000-23169 SEAGATE SOFTWARE, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) ------------------------ DELAWARE 77-0397623 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 915 DISC DRIVE 95066 SCOTTS VALLEY, CALIFORNIA (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (831) 438-6550 ------------------------ SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: SERIES A PREFERRED STOCK, $.001 PAR VALUE PER SHARE COMMON STOCK, $.001 PAR VALUE PER SHARE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K/A or any amendment to this Form 10-K/A. [X] The aggregate market value of the Common Stock held by non-affiliates of the registrant as of July 3, 1998 was $4,705,604. Shares of Common Stock held by each officer, each director, and each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The number of shares outstanding of the registrant's Common Stock as of July 3, 1998 was 975,567. DOCUMENTS INCORPORATED BY REFERENCE None. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 PART I CERTAIN FORWARD-LOOKING INFORMATION The information contained in this Form 10-K/A includes forward-looking statements. Since this information is based on current expectations that involve risks and uncertainties, actual results could differ materially from those expressed in the forward-looking statements. Various important factors known to Seagate Software, Inc. (the "Company" or "Seagate Software") that could cause such material differences are identified in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Operating Results" contained in Item 7 of this Form 10-K/A. Certain sections of this Form 10-K/A have been identified as containing forward-looking statements. The reader is cautioned that other sections and other sentences not so identified may also contain forward-looking information. ITEM 1. BUSINESS GENERAL The Company develops and markets software products and provides related services enabling business users and information technology ("IT") professionals to store, access and manage enterprise information. Headquartered in Scotts Valley, California, the Company has over 40 offices and operations in 17 countries worldwide. The Company is a majority-owned and consolidated subsidiary of Seagate Technology, Inc. (the "Parent Company" or "Seagate Technology"), a data technology company that provides products for storing, managing and accessing digital information on computer systems. As of July 3, 1998, the Parent Company and one of its subsidiaries held 99.7% of the Company's outstanding capital stock. On a diluted basis, the outstanding minority interests of the Company amounted to approximately 17.8%, which consisted of Common Stock and options to purchase its Common Stock issued pursuant to the Seagate Software 1996 Stock Option Plan (the "Option Plan"). Such options to purchase the Company's Common Stock are held by certain employees, directors and consultants of the Company and the Parent Company. The Company believes that managing the exponential growth of information and the growing need for information infrastructures combined with increasingly decentralized decision making are key challenges inherent in today's client/server computing environments. The Company's strategy is to respond to these challenges by offering Enterprise Information Management ("EIM") software solutions which consist of three core components -- Information Delivery, Information Analysis and Information Availability. The purpose of EIM is to integrate departmental information, optimize decision-making and ensure consistent access to information by providing comprehensive data availability and protection. Seagate Software is comprised of two operating groups, Information Management Group ("IMG") and Network & Storage Management Group ("NSMG"), each focused on the growing need for superior EIM. IMG offers business intelligence ("BI") software solutions featuring the Delivery and Analysis components of EIM. IMG's products include features such as query and reporting, automated report scheduling and distribution, information delivery across the World Wide Web, on-line analytical processing ("OLAP"), forecasting, statistical analysis, discovery and data mining. NSMG offers network and storage management software solutions, which focus on the Availability component of EIM by enabling IT professionals to manage distributed network resources and to secure and protect enterprise data. NSMG's products include features such as system backup, disaster recovery, migration, replication, automated client protection, storage resource management, scheduling, event correlation and desktop management. The Company's strategy is to deliver a comprehensive EIM solution to its customers by developing a technology roadmap that leverages the core competencies of its BI and network and storage management products. Combinations of EIM components are available today in a number of integrated solutions from the Company. Seagate Backup Exec, Seagate Desktop Management Suite, Seagate Manage Exec and Seagate NerveCenter provide the combination of Information Availability and Information Analysis by integrating 1 3 technology from Seagate Crystal Reports. Seagate Crystal Reports, Seagate Crystal Info and Seagate Holos provide a combination of technology that delivers Information Delivery and Information Analysis solutions. PRODUCTS Seagate Software offers a breadth of BI and network and storage management products featuring EIM functionality: EIM PRODUCTS FOR BUSINESS INTELLIGENCE - Seagate Crystal Reports for Microsoft BackOffice(TM) -- Generates a set of top-requested reports to ease systems administration functions for the Microsoft BackOffice family of products. - Seagate Crystal Info(TM) -- Provides decision-makers with shared access to reporting and analysis capabilities, so users get fast access to business information without having to interact with the database. Whether using a Web browser or Windows, users can schedule, view and analyze reports and multidimensional OLAP cubes in a secure environment. This product contains an enterprise-friendly multi-tier architecture to lower network traffic and increase user productivity. - Seagate Crystal Reports(TM) -- Provides query and report writing functions for Windows. A developer and end-user tool, Seagate Crystal Reports allows users to access most types of PC and structured query language data and design a variety of reports and integrate them into database applications. - Seagate Holos(R) -- Provides a flexible OLAP development environment for rapidly delivering a range of applications that focus on key business issues and accurately reflect business processes. These "business-aware" applications allow enterprises to harness and analyze the increasing volumes of data and guide users to the information to improve decision-making. EIM PRODUCTS FOR NETWORK AND STORAGE MANAGEMENT - Seagate Backup Exec(R) Desktop Editions -- Provides complete plug-and-play backup and restore functions for desktop users running Microsoft Windows NT Workstation, Windows 98, Windows 95, Windows 3.x and DOS. - Seagate Backup Exec(R) Server and Enterprise Editions -- Provides a backup and restore solution for server and network users running Novell NetWare, Microsoft Windows NT LANs and workstations. - Seagate Backup Exec(R) Storage Migrator -- Facilitates the proactive management of inactive data by migrating it from on-line storage (such as disk drives) to near-line devices (such as optical drives) or to archival storage resources (such as tape devices) over user-defined periods of time through a multi-tier hierarchical storage management ("HSM") application delivering enterprise functionality to client/server environments. - Seagate Client Exec(TM) -- Protects critical client data on workstations and laptops. Users receive automatic, regular and transparent protection of their critical data, and administrators have the flexibility to control which users are protected, what type of data is protected and when the protection should occur. - Seagate Desktop Management Suite(TM) -- Provides a fully integrated suite of software solutions including network inventory, software distribution, remote control, network backup and software metering. - Seagate ExecView(TM) -- Provides an integrated cross-platform storage management console for enterprise networks using Microsoft Windows NT and Novell NetWare. Users can manage both Seagate Backup Exec for NetWare and Seagate Backup Exec for Windows NT servers from a single console. - Seagate Manage Exec(TM) -- Centralizes enterprise administration by providing IT professionals with a unique view of servers worldwide and real-time problem analysis through a proactive server health monitoring, alerting and reporting solution. 2 4 - Seagate NerveCenter(R) -- Provides an enterprise-event automation solution for Windows NT and UNIX environments. - Seagate WinINSTALL(TM) -- Provides a script-free, automated software distribution tool for 16- and 32-bit applications. The Company provides its software products to customers under non-exclusive, non-transferable license agreements (including shrink-wrap licenses for certain products). As is customary in the software industry, in order to protect its intellectual property rights, the Company does not sell or transfer title to its software products to customers. The Company enters into both object-code only and source-code licenses of its products. Under the Company's current standard end-user license agreement, licensed software may be used solely for the customers' internal operations and only at specified sites, which may be comprised of a stand-alone computer, a single network server with multiple terminals or multiple network servers with multiple terminals. STRATEGIC RELATIONSHIPS The Company has developed strategic relationships with a number of application software developers and computer hardware manufacturers that sell and support the Company's products as well as integrate the Company's products into their operating system platforms. Such strategic relationships have been established with Compaq, Hewlett-Packard, IBM, Informix, Microsoft, Netscape, Novell, Oracle, PeopleSoft and Seagate Technology's original equipment manufacturer ("OEM") tape drive operations. The Company's strategic relationship with Microsoft includes the bundling of its leading BI and storage management products with selected Microsoft products. Seagate Crystal Reports is bundled with Microsoft BackOffice products and developer tools such as Microsoft Visual Basic, and Seagate Crystal Info is bundled in BackOffice Server 4.0. Additionally, the Company developed the backup utility for Microsoft Windows 98 and is developing the system disaster recovery and backup utilities for Windows NT 5.0. The Company has also developed the HSM technology to be included in Windows NT Server 5.0.* RESEARCH AND DEVELOPMENT The Company incurred research and development expenses of approximately $47,173,000, $42,842,000 and $36,897,000 in 1998, 1997 and 1996, respectively. Certain of the research and development expenses, which have not been material to date, are funded by the Company's customers. The Company is pursuing its product development objectives by continuing its emphasis on internally developing new software products and product enhancements, acquiring products, technologies and businesses complementary to the Company's existing product lines and forming alliances with leading technology companies.* SALES AND MARKETING The Company employs a multi-faceted sales strategy. The Company utilizes direct sales forces and certain indirect sales channels, such as distributors and OEM relationships, for sales of its selected products to end users. These distributors and OEMs may also sell other products that are complementary to or compete with those of the Company. The Company provides sales and marketing programs to encourage the sale of its products, but there can be no assurance that its distributors and OEMs will not place a higher priority on competing products. Agreements with its distributors and OEMs are generally non-exclusive and may be terminated by either party without cause. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Operating Results." - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Readers are cautioned that other sections and other sentences not so identified may also contain forward-looking information. 3 5 The Company generally markets its products domestically and overseas through a network of wholly-owned subsidiaries. These subsidiaries utilize authorized distributors and direct sales forces. The Company adapts certain products for foreign markets, including translation and documentation, and the Company prepares marketing and sales support programs accordingly. The Company has organized its sales management into geographical regions to increase the effectiveness of its sales efforts. Each region has offices established in cities and countries near its largest existing or prospective partners and customers. There are four regions: the Americas, Europe/Middle East/Africa, Japan, and Asia/Pacific. The Company's marketing efforts are designed to increase awareness and consideration of, and to generate leads for, the Company's products. Marketing activities include print advertising in trade and technical publications, on-line advertising on the World Wide Web, cooperative marketing with distributors and resellers, participation in seminars and tradeshows, mailings to end users and other public relations efforts. The Company's marketing groups produce or oversee the production of substantially all of the on-line and print product literature, brochures, advertising and similar marketing and promotional material for the Company. Revenue from one third party customer, Ingram Micro Inc., accounted for 22%, 18% and 16% of the Company's total revenues in 1998, 1997 and 1996, respectively. Indirect revenues, which include sales to distributors and OEMs, were 69%, 63% and 70% of total revenues during 1998, 1997 and 1996, respectively. Revenues outside of the Americas were 32%, 30% and 11% of total revenues during 1998, 1997 and 1996, respectively. During 1998 the Company generated export revenues from the United States of approximately $66,250,000. Revenues and expenses from the Company's operations outside of the Americas were approximately $26,809,000 and $52,143,000, respectively, as translated to the U.S. dollar from foreign currencies. The principal currency for such operations is the British pound. The Company believes that its exposure to foreign currency fluctuations is not material and does not engage in foreign currency hedging programs.* TECHNICAL SUPPORT AND MAINTENANCE The Company's technical support groups, located at various sites around the world, including the U.S., Canada and Europe, provide pre-sale, installation and post-sale support to current users and potential customers evaluating the Company's products. Certain technical support groups also offer seven-day, 24-hour toll-free telephone services. The Company believes that effective technical support during product evaluation substantially contributes to product acceptance, and that post-sale support has been, and will continue to be, a substantial factor in maintaining customer satisfaction.* The Company offers maintenance programs for certain of its software products, which may consist of product enhancements, updated products and technical support. Generally, customers renew maintenance and support on an annual basis by paying a maintenance fee. Maintenance revenue implicit in new product sales and recurring maintenance charges are recognized ratably over the period the maintenance and support services are to be provided. COMPETITION The business intelligence and network and storage management software markets in which the Company competes are comprised of numerous competitors, and the Company expects competition to increase.* The Company has recently experienced increased competition from additional entrants into its markets, including companies that specialize in the development, marketing and support of information management and network and storage management software products. Many of the Company's current and prospective - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Readers are cautioned that other sections and other sentences not so identified may also contain forward-looking information. 4 6 competitors have significantly greater financial, technical and marketing resources than the Company. In addition, many prospective customers may have the internal capability to implement solutions to their problems. The competitive factors affecting the market for the Company's software products include the following: product functionality; performance and reliability; demonstrable economic benefits for users relative to cost; price; quality of customer support and user documentation and ease of installation; vendor reputation; experience; and financial stability. The Company believes that it currently competes effectively with respect to these factors. The Company's ability to remain competitive will depend, to a great extent, upon its ongoing performance in the areas of product development and customer support.* To be successful in the future, the Company must respond promptly and effectively to the challenges of technological change and its competitors' innovations by continually enhancing its own product offerings.* Performance in these areas will, in turn, depend upon the Company's ability to attract and retain highly qualified technical personnel in a competitive market for experienced and talented software developers.* The Company also expects to continue its strategy of identifying and acquiring business intelligence and network and storage management assets and technologies and businesses that have developed such products and technologies.* PATENTS AND INTELLECTUAL PROPERTY RIGHTS The Company by and through its Parent Company and/or predecessor companies, has been awarded four (4) United States patents and has three (3) United States and three (3) foreign patent applications pending. Because software technology changes rapidly, the Company believes that the improvement of existing products, reliance upon trade secrets and unpatented proprietary know-how and development of new products are generally more important than patent protection. The Company nevertheless believes that patents are of value to its business and intends to continue its efforts to obtain patents, when available, in connection with its research and development programs.* There can be no assurance that any patents obtained will provide substantial protection or be of commercial benefit to the Company, or that their validity will not be challenged. The Company's license agreements have restrictions in place to protect and defend the Company's intellectual property. The Company realizes that although it has incorporated these restrictions, there is a possibility for unauthorized use of its software. In addition to relying on these contractual rights, the Company has an ongoing trademark registration program in which it registers certain of its product names, slogans, and logos in the United States and in some foreign countries. EMPLOYEES As of July 3, 1998, the Company employed approximately 1,800 persons. The Company's success is highly dependent on its ability to attract and retain qualified employees. Competition for qualified employees is intense in the software industry. None of the Company's employees are represented by a labor union or are the subject of a collective bargaining agreement. The Company has never experienced a work stoppage and believes that its employee relations are good. - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Readers are cautioned that other sections and other sentences not so identified may also contain forward-looking information. 5 7 ITEM 2. PROPERTIES Seagate Software's executive offices are located in Scotts Valley, California. Principal facilities are located in Florida, California, Canada and the United Kingdom. A major portion of the Company's facilities are occupied under leases that expire at various times through 2008. The following is a summary of square footage leased by the Company: FACILITIES TOTAL LOCATION SQUARE FEET -------- ----------- North America California Central California..................................... 53,429 Northern California.................................... 16,084(1) Colorado.................................................. 18,348 Mid-Continent............................................. 7,607 Northeast USA............................................. 33,428 Southeast USA............................................. 121,112(2) Other USA................................................. 5,481(3) Canada.................................................... 140,044 --------- Total North America............................... 395,533 Europe England................................................... 39,141 Germany................................................... 6,858(4) Other Europe.............................................. 10,379 --------- Total Europe...................................... 56,378 Asia Australia................................................. 11,233 Japan..................................................... 6,938 Hong Kong................................................. 2,206 Other Pacific Rim......................................... 3,885 --------- Total Asia........................................ 24,262 --------- Total............................................. 476,173 ========= - --------------- (1) Excludes approximately 44,361 square feet of space leased to others. (2) Excludes approximately 5,000 square feet of unoccupied space. (3) Excludes approximately 19,206 square feet of unoccupied space. (4) Excludes approximately 3,263 square feet of space leased to others. ITEM 3. LEGAL PROCEEDINGS On November 10, 1997, Vedatech Corporation commenced an action in the High Court of Justice Chancery Division in the United Kingdom against Seagate Software Information Management Group Ltd. claiming breach of an oral agreement and infringement of a Vedatech U.K. copyright in the Japanese translation of one of the Company's products (the "Complaint") and seeking monetary and injunctive relief. No specific damage amount has yet been claimed. The Company has hired local counsel in the U.K., reviewed documents and conducted interviews. The Company filed an initial response in the U.K. court on January 13, 1998 and is now in the discovery process. The Company believes the Complaint has no merit and intends to vigorously defend the action. However, if an unfavorable outcome were to arise, there can be no assurance that such outcome would not have a material adverse effect on the Company's liquidity, financial position or results of operations. 6 8 In addition to the foregoing, the Company is engaged in legal actions arising in the ordinary course of its business and believes that the ultimate outcome of these actions will not have a material adverse effect on the Company's financial position, liquidity, or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS As of July 3, 1998, the Company had outstanding 975,567 shares of Common Stock held by 225 shareholders and 54,633,333 shares of Series A Preferred Stock (including shares exchangeable to Series A Preferred Stock) held by the Parent Company and one of its subsidiaries. There is no established public trading market for any class of the Company's securities. The Company has not paid any dividends on any of its capital stock and does not anticipate that any cash dividends will be declared in the foreseeable future.* ITEM 6. SELECTED FINANCIAL DATA The consolidated financial data with respect to the fiscal years ended July 3, 1998, June 27, 1997 and June 28, 1996 are derived from the audited Consolidated Financial Statements of the Company that are included or incorporated by reference in this Form 10-K/A. The consolidated financial data set forth below with respect to the fiscal years ended June 30, 1995 and July 1, 1994 are derived from the Consolidated Financial Statements of the Company that are not included in this Form 10-K/A. The following data should be read in conjunction with the Consolidated Financial Statements and notes thereto included elsewhere in this Form 10-K/A and in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere herein. FISCAL YEAR ENDED ------------------------------------------------------- JULY 3, JUNE 27, JUNE 28, JUNE 30, JULY 1, 1998 1997 1996 1995 1994 -------- -------- -------- -------- ------- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Revenues.............................. $293,226 $216,950 $141,586 $92,796 $30,696 Gross profit.......................... 242,766 169,161 112,567 70,417 23,556 Income (loss) from operations......... 6,125 (60,296) (137,806) (80,166) (11,068) Net loss.............................. (9,270) (53,963) (129,668) (82,864) (6,884) Net loss per common share (basic and diluted)............................ (56.33) (796.93) Total assets.......................... 138,997 147,331 201,598 101,928 20,854 Stockholders' equity.................. $ 57,106 $ 63,355 $115,602 $47,215 $ 6,978 Weighted average common shares outstanding......................... 164,571 67,714 - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Readers are cautioned that other sections and other sentences not so identified may also contain forward-looking information. 7 9 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CERTAIN FORWARD-LOOKING INFORMATION Certain statements in this Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") of Seagate Software and contained elsewhere in this Form 10-K/A are forward-looking statements based on current expectations, and entail various risks and uncertainties that could cause actual results to differ from those projected in such forward-looking statements. Certain of these risks and uncertainties are set forth below in the sections entitled "Liquidity and Capital Resources" and "Factors Affecting Seagate Software's Future Operating Results". Certain sections in this Form 10-K/A have been identified as containing forward-looking statements. The reader is cautioned that other sections and other sentences not so identified may also contain forward-looking information. OVERVIEW Seagate Software develops and markets software products and provides related services enabling business users and information technology professionals to manage enterprise information. Headquartered in Scotts Valley, California, Seagate Software has over 40 offices and operations in 17 countries worldwide. The Company is a majority-owned and consolidated subsidiary of Seagate Technology, Inc. (the "Parent Company" or "Seagate Technology"), a data technology company that provides products for storing, managing and accessing digital information on computer systems. As of July 3, 1998, the Parent Company and one of its subsidiaries held 99.7% of Seagate Software's outstanding capital stock. On a fully converted basis the outstanding minority interests of Seagate Software amounted to approximately 17.8%, which consisted of common stock and options to purchase its common stock issued pursuant to the 1996 Stock Option Plan (the "Option Plan") and common stock subject to repurchase. Such options and stock are held by certain current and former employees, directors and consultants of Seagate Software and Seagate Technology. Seagate Software was incorporated in Delaware in November 1993 and commenced operations in May 1994 pursuant to Seagate Technology's merger with Crystal Computer Services, Inc., a company engaged in developing and marketing report writing software. From August 1994 to June 1996, Seagate Technology acquired eight software companies, which were engaged in developing and marketing business intelligence ("BI") or network and/or storage management software products. In February 1996, Seagate Technology merged with Conner Peripherals, Inc. in a transaction accounted for as a pooling-of-interests. In connection with the merger, Seagate Technology purchased the outstanding minority interests in Conner's storage management software operations under Arcada Holdings, Inc. ("Arcada") for $85.1 million, which resulted in allocations to goodwill and other intangibles for $47.4 million, write off of in-process research and development of $43.9 million and a deferred tax liability of $6.3 million. In April 1996, the Parent Company consolidated its software operations into Seagate Software. In June 1998, the Company acquired all of the outstanding capital stock of Eastman Software Storage Management Group, Inc. , a company engaged in developing, producing and marketing hierarchical storage management products for the Windows NT platform. The purchase price of approximately $10,000,000 was paid in cash which resulted in allocations to goodwill and other intangibles of $3.2 million and a write off of in-process research and development of $6.8 million. Seagate Software accounted for the acquisition using the purchase method, and the results of operations of Eastman are only included in Seagate Software's operations since the acquisition was completed. Seagate Software operates and reports financial results on a fiscal year of 52 or 53 weeks ending on the Friday closest to June 30. Accordingly, fiscal 1998 ended on July 3, 1998, fiscal 1997 ended on June 27, 1997 and fiscal 1996 ended on June 28, 1996. Fiscal 1998 was comprised of 53 weeks and fiscals 1997 and 1996 were comprised of 52 weeks. All references to years in this Form 10-K/A represent fiscal years unless otherwise noted. 8 10 BUSINESS COMBINATIONS Valuation Methodology In accordance with the provisions of APB Opinion 16, all identifiable assets, including identifiable intangible assets, were assigned a portion of the cost of the acquired enterprise (purchase price) on the basis of their respective fair values. This included the portion of the purchase price properly attributed to incomplete research and development projects that should be expensed according to the requirements of Interpretation 4 of SFAS No. 2. Intangible assets were identified through (i) analysis of the acquisition agreement, (ii) consideration of the Network & Storage Management Group's intentions for future use of the acquired assets, and (iii) analysis of data available concerning Arcada's products, technologies, markets, historical financial performance, estimates of future performance and the assumptions underlying those estimates. The economic and competitive environment in which the Network & Storage Management Group and Arcada operate was also considered in the valuation analysis. Specifically, purchased research and development ("purchased R&D") was identified and valued through extensive interviews and discussions with the Network & Storage Management Group and Arcada management and the analysis of data provided by Arcada concerning Arcada's developmental products, their respective stage of development, the time and resources needed to complete them, their expected income generating ability, target markets and associated risks. The Income Approach, which includes an analysis of the markets, cash flows, and risks associated with achieving such cash flows, was the primary technique utilized in valuing each purchased R&D project. A portion of the purchase price was allocated to the developmental projects based on the appraised fair values of such projects. ARCADA SOFTWARE, INC. Overview As of the acquisition date, Arcada had spent a significant amount of money on research and development related to the re-development efforts to add features and utilities to the Desktop, NetWare and Windows NT products such as disk grooming, hierarchical storage management, upgraded graphical user interfaces, file and server replication, and server mirroring in order to continue to meet increasingly complex user needs. In accordance with SFAS 86, paragraph 38 ("Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed"), "the cost of software purchased to be integrated with another product or process will be capitalized only if technological feasibility was established for the software component and if all research and development activities for the other components of the product or process were completed at the time of the purchase." Although Seagate purchased existing products from Arcada, since the majority of the original underlying code and base technology for the NetWare and Windows NT product families was completed in the 1990 time frame, the technologies, as of the date of valuation, were desperately in need of, and therefore, as mentioned above, was undergoing significant re-development. Assumptions Revenue Future revenue estimates were generated for the following product families: (i) Desktop, (ii) NetWare, and (iii) Windows NT. Aggregate revenue for Arcada products was estimated to be approximately $94 million for the ten and one-half months ending December 31, 1996. Revenues were estimated to increase to approximately $161 million and $233 million for calendar years 1997 and 1998 when most of the in-process projects were expected to be complete and shipping. Thereafter, revenue was estimated to increase at rates ranging from 35% to 40% for calendar years 1999 through 2002. Revenue estimates were based on (i) aggregate revenue growth rates for the business as a whole, (ii) individual product revenues, (iii) growth rates for the storage management software market, (iv) the aggregate size of the storage management 9 11 software market, (v) anticipated product development and introduction schedules, (vi) product sales cycles, and (vii) the estimated life of a product's underlying technology. The estimated product development cycle for the new products ranged from 12 to 18 months. Operating expenses Operating expenses used in the valuation analysis of Arcada included (i) cost of goods sold, (ii) general and administrative expense, (iii) selling and marketing expense, and (iv) research and development expense. In developing future expense estimates, an evaluation of both Seagate Software and Arcada's overall business model, specific product results, including both historical and expected direct expense levels (as appropriate), and an assessment of general industry metrics was conducted. Cost of goods sold. Cost of goods sold, expressed as a percentage of revenue, for the developed and in-process technologies ranged from approximately 5% to 30% (30% for Desktop, 10% for NetWare, and 5% for Windows NT). Seagate Software's cost of goods sold was 20% for fiscal 1996, 22% for fiscal 1997, and 17% for fiscal 1998. General and administrative ("G&A") expense. G&A expense, expressed as a percentage of revenue, for the developed and in-process technologies ranged from 12% in calendar 1996 to 8% in calendar 1998 and beyond. Selling and marketing ("S&M") expense. S&M expense, expressed as a percentage of revenue, for the developed and in-process technologies was estimated to be 30% throughout the estimation period. Research and development ("R&D") expense. R&D expense consists of the costs associated with activities undertaken to correct errors or keep products updated with current information (also referred to as "maintenance" R&D). Maintenance R&D includes all activities undertaken after a product is available for general release to customers to correct errors or keep the product updated with current information. These activities include routine changes and additions. The maintenance R&D expense was estimated to be 5% of revenue for the developed technologies and 3% of revenue for the in-process technologies throughout the estimation period. In addition, as of the date of acquisition, Seagate Software management anticipated the costs to complete the Desktop, NetWare, and Windows NT technologies at approximately $6.8 million, $4.5 million, and $7.5 million, respectively. Since the acquisition date, all projects originally acquired from Arcada were commercially released prior to the end of the fourth quarter of fiscal 1997. Effective tax rate The effective tax rate utilized in the analysis of developed and in-process technologies was 38%, which reflects Seagate's combined federal and state statutory income tax rates, exclusive of non-recurring charges at the time of the acquisition and estimated for future years. Discount rate The discount rates selected for Arcada's developed and in-process technologies were 15% and 17.5%, respectively. In the selection of the appropriate discount rates, consideration was given to (i) the Weighted Average Cost of Capital (approximately 13% to 15% at the date of acquisition) and (ii) the Weighted Average Return on Assets (approximately 18%). The discount rate utilized for the in-process technology was determined to be higher than Seagate's WACC due to the fact that the technology had not yet reached technological feasibility as of the date of valuation. In utilizing a discount rate greater than Seagate's WACC, management has reflected the risk premium associated with achieving the forecasted cash flows associated with these projects. 10 12 EASTMAN SOFTWARE STORAGE MANAGEMENT GROUP. Overview Eastman Software SMG's two primary products are OPEN/stor for Windows NT and AvailHSM for NetWare. By integrating Eastman's product line, Seagate will be able to convert their Storage Migrator product into a stand-alone HSM application for Windows NT environments. As of the date of acquisition, the Company abandoned the AvailHSM product and technology due to dated features and functionality; the valuation analysis did not include a fair value for the AvailHSM product. As for OPEN/stor at the date of acquisition, the Company planned to phase out the product over the following 12 to 15 months. Seagate's purpose for the acquisition was for the next generation technologies that were underway at Eastman, referenced by project names Sakkara and Phoenix. These projects were complete re-writes of Eastman's prior generation technology that would allow the product to be sold stand-alone upon completion. In accordance with SFAS 86, paragraph 38 ("Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed"), "the cost of software purchased to be integrated with another product or process will be capitalized only if technological feasibility was established for the software component and if all research and development activities for the other components of the product or process were completed at the time of the purchase." Although Seagate purchased existing products from Eastman, the existing products did not operate on a stand-alone basis. Therefore, as mentioned above, all of the original underlying code and base technology for the next generation products were in the process of being completely re-written as date of valuation. Assumptions Revenue Future revenue estimates were generated for the following technologies: (i) OPEN/stor, (ii) Sakkara, and (iii) Phoenix. Aggregate revenue for existing Eastman products was estimated to be approximately $167,000 for the one month ending June 30, 1998. Revenues were estimated to increase to approximately $3.9 million and $7.1 million for fiscal years 1999 and 2000 when most of the in-process projects were expected to be complete and shipping. Thereafter, revenue was estimated to increase at rates ranging from 20% to 30% for fiscal years 2001 through 2006. Revenue estimates were based on (i) aggregate revenue growth rates for the business as a whole, (ii) individual product revenues, (iii) growth rates for the storage management software market, (iv) the aggregate size of the storage management software market, (v) anticipated product development and introduction schedules, (vi) product sales cycles, and (vii) the estimated life of a product's underlying technology. Operating expenses Operating expenses used in the valuation analysis of Eastman included (i) cost of goods sold, (ii) general and administrative expense, (iii) selling and marketing expense, and (iv) research and development expense. In developing future expense estimates, an evaluation of both Seagate and Eastman's overall business model, specific product results, including both historical and expected direct expense levels (as appropriate), and an assessment of general industry metrics was conducted. Cost of goods sold. Cost of goods sold, expressed as a percentage of revenue, for the developed and in-process technologies was estimated to be approximately 5% throughout the estimation period. Seagate Software's cost of goods sold was 20% for fiscal 1996 and 22% for fiscal 1997. General and administrative ("G&A") expense. G&A expense, expressed as a percentage of revenue, for the developed and in-process technologies was estimated to be approximately 10% throughout the estimation period. 11 13 Selling and marketing ("S&M") expense. S&M expense, expressed as a percentage of revenue, for the developed and in-process technologies was estimated to be 27% throughout the estimation period. Research and development ("R&D") expense. R&D expense consists of the costs associated with activities undertaken to correct errors or keep products updated with current information (also referred to as "maintenance" R&D). Maintenance R&D includes all activities undertaken after a product is available for general release to customers to correct errors or keep the product updated with current information. These activities include routine changes and additions. The maintenance R&D expense was estimated to be 5% of revenue for the developed and in-process technologies throughout the estimation period. In addition, as of the date of acquisition, Seagate Software's management anticipated the costs to complete the in-process technologies at approximately $1.8 million. Effective tax rate The effective tax rate utilized in the analysis of developed and in-process technologies was 38%, which reflects Seagate's combined federal and state statutory income tax rates, exclusive of non-recurring charges at the time of the acquisition and estimated for future years. Discount rate The discount rates selected for Eastman's developed and in-process technologies were 15% and 20%, respectively. In the selection of the appropriate discount rates, consideration was given to (i) the Weighted Average Cost of Capital (approximately 15% at the date of acquisition) and (ii) the Weighted Average Return on Assets (approximately 18%). The discount rate utilized for the in-process technology was determined to be higher than Seagate's WACC due to the fact that the technology had not yet reached technological feasibility as of the date of valuation. In utilizing a discount rate greater than Seagate's WACC, management has reflected the risk premium associated with achieving the forecasted cash flows associated with these projects. CALYPSO SOFTWARE SYSTEMS, INC. Calypso is a software developer in the enterprise network/system management market. Calypso provides software which is designed to enable companies to automate the management of their distributed applications. At the date of acquisition, Calypso had two main products: Maestro Vision ("Maestro") and Atrium Extendible Management System ("EMS") for Spectrum. Both existing products, as of the acquisition date, were planned to be phased out over the following 24 months. Calypso, at the acquisition date, was in the process of developing the next generation Atrium EMS product that can be sold stand-alone. Both Maestro and Atrium EMS for Spectrum were originally designed for use only on certain system platforms, Cabletron and Spectrum, respectively. However, Atrium EMS (stand-alone) would allow systems managers on any system platform to distribute software; monitor CPU, memory, and operating system administration; manage applications, file systems, and print services; and perform UNIX and NT system administration. As of the date of acquisition, Calypso had undergone or was in the process of undergoing the re-write of code in C+, adding navigator capabilities, developing web server and browser interoperability, developing CORBA interoperability, and developing Network OLE/COM interoperability for Atrium EMS (stand-alone). The estimated cost to complete, at the date of acquisition, was approximately $750,000. These in process research and development projects were successfully completed prior to a restructuring of operations in the third quarter of fiscal 1997. As a result of this restructuring and a change in Seagate Software's strategic direction, in the first quarter of fiscal 1998 Seagate Software disposed of all the developed and in process technologies originally acquired from Calypso. ONDEMAND SOFTWARE, INC. OnDemand develops and markets electronic software distribution products involved in network management in the client/server environment. OnDemand's flagship product is WinINSTALL. As of the date of 12 14 acquisition, OnDemand was in the process of developing the next generation of WinINSTALL Version 6.0. A significant feature of Version 6.0 (not available by any competitive product) was a rollback with clone capability, which would allow the user to selectively return a PC to a previous state upon installation failure or upon user demand. In order for WinINSTALL Version 6.0 to become a commercially viable product, OnDemand, as of the valuation date, had undergone or was in the process of undergoing significant development efforts, including (i) developing rollback facilities, including clone capability, (ii) expanding global editor to be included in the WinINSTALL registry file, (iii) improving WinINSTALL Remote to ease package generation and distribution, (iv) adding a feature that would allow optional electronic mail notification on installation failure and on installation refusals due to reaching license limitations, and (v) expanding copy options and interactive install displays, adding substitution variables, and allowing version control of backup files. As of the date of acquisition, Seagate Software management anticipated the costs to complete WinINSTALL Version 6.0 at approximately $920,000. Since the acquisition date, the acquired in-process research and development from OnDemand has been completed and the related products have been released prior to the end of fiscal 1997. HOLISTIC SYSTEMS LTD. Holistic's sole software product is Holos -- a product that enables users to develop and utilize the wide variety of applications found in large scale management information systems. As of the date of acquisition, Holistic was in the process of developing the next generation of Holos, version 6.0, which was planned for release during the summer of 1997. As of the date of acquisition, Holistic had undergone or was in the process of undergoing the re-write of the front-end code of the system from C to C++, the re-write of the back-end code of the system in C, and the creation of the Holos product to be object oriented. The estimated cost to complete, at the date of acquisition, was approximately $3.5 million. Since the acquisition date, the project originally acquired from Holistic was commercially released as planned, fourth quarter of fiscal 1997. RESTATEMENT OF FINANCIAL STATEMENTS Seagate Software had previously allocated a portion of goodwill to developed technology and evaluated the impairment of goodwill based on the revenues from the related software. Using this method, Seagate Software recorded write-downs and write-offs of goodwill in fiscal 1997 in the amount of $10,259,000. Seagate Software has re-evaluated its methodology and determined that goodwill should not be allocated to developed technology under Accounting Principles Board Opinion 17, "Intangible Assets". As a result, Seagate Software has made adjustments to decrease the amounts of goodwill previously written-down and written-off from $10,259,000 to $6,173,000 in fiscal 1997. The additional goodwill of $4,086,000 is being amortized over the remaining estimated useful lives of approximately 5 years. The effect of this adjustment on previously reported consolidated financial statements as of and for the years ended July 3, 1998 and June 27, 1997 is as follows (in thousands except per share amounts): AS REPORTED AS RESTATED ---------------------------- ---------------------------- JULY 3, 1998 JUNE 27, 1997 JULY 3, 1998 JUNE 27, 1997 ------------ ------------- ------------ ------------- Amortization of goodwill........................ $ 15,421 $ 27,202 $ 16,201 $ 23,465 Income (loss) from operations................... 6,905 (64,033) 6,125 (60,296) Net income (loss)............................... (8,490) (57,700) (9,270) (53,963) Basic and diluted (loss) per share.............. (51.59) (852.11) (56.33) (796.93) Goodwill and other intangible assets, net....... 53,879 75,306 56,836 79,043 Accumulated deficit............................. (289,175) (280,685) (286,218) (276,948) FISCAL YEAR 1998 VERSUS FISCAL YEAR 1997 REVENUES. Total revenues increased 35% to $293,226,000 in 1998 from $216,950,000 in 1997. License revenues grew 33% to $243,285,000 in 1998 from $183,556,000 in 1997 due primarily to increased sales of 13 15 Seagate Backup Exec, the Network & Storage Management Group business's leading storage management product featuring backup and restore solutions for Microsoft's Windows NT Server and Windows NT Workstation operating systems. License revenue growth was also due to increased sales of Seagate Crystal Reports and Seagate Crystal Info, the Information Management Group's leading business intelligence products featuring enterprise report writing and scheduling technologies. Seagate Software continued to expand both its indirect and direct sales channels. Indirect revenues, which include distribution and OEM sales, increased 37% to $203,273,000 in 1998 from $147,991,000 in 1997 while direct revenues, which include corporate licensing and other direct sales to users, increased 30% to $89,953,000 in 1998 from $68,959,000 in 1997. Revenues increased within the Americas 30% to $198,820,000 in 1998 from $153,368,000 in 1997 and internationally 48% to $94,407,000 in 1998 from $63,582,000 in 1997, which was due in part to Seagate Software's continued expansion of its European distribution channel. Revenues from Seagate Technology decreased 5% primarily due to fewer unit shipments to Seagate Technology's OEM tape drive operations. Total maintenance, support and other revenues grew 61% to $44,472,000 in 1998 from $27,632,000 in 1997 primarily due to increases in the sales of maintenance agreements and training and consulting services resulting from a larger installed customer base. During 1998 Seagate Software generated export revenues from the United States of approximately $66,250,000. Revenues and expenses from Seagate Software's operations outside of the Americas were approximately $26,809,000 and $52,143,000, respectively, as translated to the U.S. dollar from foreign currencies. The principal currency for such operations is the British pound. Seagate Software believes that its exposure to foreign currency fluctuations is not material and does not engage in foreign currency hedging programs.* COST OF REVENUES. The decrease in the cost of license revenues to $16,963,000 in 1998 from $17,535,000 in 1997, representing 7% and 10% of related license revenues, respectively, and the decrease in the cost of license revenues from Seagate Technology was due primarily to reductions in product packaging and documentation costs resulting from a shift in mix to CD-ROMs from disks and increased sales of higher-margin server products. The increase in the cost of maintenance, support and other revenues to $19,687,000 in 1998 from $6,560,000 in 1997, representing 44% and 24% of related service revenues, respectively, was primarily due to expansion of Seagate Software's professional services workforce necessary to support the growth in training and consulting revenues. The lower service revenue margins in 1998 were primarily due to increased spending for additional personnel and new facilities to support higher levels of customer support services, such as training, consulting and preferred technical support. The decrease in the amortization of developed technology to $13,271,000 in 1998 from $21,860,000 in 1997, representing 5% and 10% of total revenues, respectively, was primarily due to write-downs of certain developed technologies amounting to approximately $6,918,000 during 1997 as a result of asset values that had become impaired based on reductions in estimated future cash flows. Unamortized software costs for developed technology were reviewed under the guidance of SFAS No. 86 for potential impairment. Seagate Software compares the undiscounted future cash flows on a product by product basis to the unamortized costs including goodwill. Unamortized costs, including goodwill, in excess of undiscounted future cash flows are recorded as an impairment loss. Impairment losses in 1997 were caused by a number of factors including Seagate Software's business decision to stop selling products or technologies such as DOS, new acquisitions, or new product designs. Additionally in 1997, Seagate Software incurred a write-off related to the decision to close down and sell one of its acquisitions, Calypso Software Systems, Inc. The write-off was to the expected net realizable value. Seagate Software is not currently generating any revenues from any products for which the related developed technology has been impaired. - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Readers are cautioned that other sections and other sentences not so identified may also contain forward-looking information. 14 16 SALES AND MARKETING. The increase in sales and marketing expenses to $129,343,000 in 1998 from $107,706,000 in 1997, representing 44% and 50% of total revenues, respectively, was primarily due to expansion of Seagate Software's sales force and increases in advertising, promotion, including allocations from Seagate Technology for the proportional cost of television and newspaper advertisements and technical support costs necessary to support revenue growth. Such increases were partially offset by reductions in workforce in 1997 within the Network & Storage Management Group business unit due to facility consolidations. RESEARCH AND DEVELOPMENT. The increase in research and development expenses to $47,173,000 in 1998 from $42,842,000 in 1997, representing 16% and 20% of total revenues, respectively, was primarily due to increases in personnel and related expenses, new product development and localization costs, partially offset by facility consolidations and reductions in workforce in 1997 within the Network and Storage Management Group business unit. GENERAL AND ADMINISTRATIVE. The increase in general and administrative expenses to $37,124,000 in 1998 from $36,861,000 in 1997, representing 13% and 17% of total revenues, respectively, was primarily due to increases in personnel and related expenses and legal costs, partially offset by facility consolidations and reductions in workforce in 1997 within the Network & Storage Management Group business unit. WRITE-OFF OF IN-PROCESS RESEARCH AND DEVELOPMENT. As a result of its acquisitions, Seagate Software has acquired a number of projects and products that were considered in-process research and development on the date of acquisition. Seagate Software determined that purchased in-process technology had not reached technological feasibility as no working model or detail program design existed at the time of purchase, and no alternative uses had been identified. Accordingly, in-process research and development was expensed when acquired. During 1998, $6,800,000 of in-process research and development was written off in connection with the purchase of Eastman Software Storage Management Group, Inc. During 1997, total write-offs of in-process research and development were $2,613,000. Seagate Software incurred this charge in connection with additional amounts paid with respect to the June 1996 acquisition of Holistic Systems, Ltd. ("Holistic"). AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. The decrease in the amortization of goodwill and other intangibles to $16,201,000 in 1998 from $23,465,000 in 1997, representing 6% and 11% of total revenues, respectively, was primarily due to decreases in amortization expense based on lower levels of intangible assets and write-downs and write-offs of the carrying value of developed technology of approximately $1,900,000 in 1998 versus $6,173,000 in 1997 as a result of asset values that had become impaired based on reductions in estimated future cash flows. Long-lived assets other than developed technology, including associated goodwill, are assessed for impairment under the guidance of Statement of Financial Accounting Standards Board No. 121 ("SFAS 121"), and any write-offs or write-downs are included in amortization of goodwill and other intangibles. Goodwill not within the scope of SFAS 121 is assessed for impairment under the guidance of Accounting Principles Board No. 17, and any write-offs or write-downs are also included in amortization of goodwill and other intangibles. Developed technology acquired in business combinations is assessed for impairment under the guidance of Statement of Financial Accounting Standards Board No. 86, and any related write-offs or write-downs are included in costs of revenues. During fiscal 1997 and 1998, Seagate Software recorded impairment charges for write-offs and write-downs of acquired intangible assets and goodwill, exclusive of amounts relating to developed technology included in costs of revenues, as follows: In 1997, Seagate Software determined that it would abandon and discontinue selling substantially all of the current and future products and technologies obtained in the 1994 acquisition of Palindrome Corporation in favor of selling and supporting the current and future products and technologies obtained in the 1996 acquisition of Arcada Holdings, Inc. Additionally, in 1997, Seagate Software decided to close down and sell Calypso Software Systems, Inc. and to abandon and discontinue sales of the developed and future DOS products and technologies acquired from Frye Computer Systems, Inc. In connection with these determinations, Seagate Software recorded impairment charges to write-off and write-down goodwill amounting to approximately $6.2 million. 15 17 In 1998, Seagate Software capitalized the acquired assembled workforce in most of its acquisitions. When Seagate Software reviews the carrying value of its intangibles, if there remains less than 5% of the original assembled workforce the related intangible assets is deemed impaired. In fiscal 1998, Seagate Software wrote-off a total of $1.9 million relating to the capitalized assembled workforces and the associated goodwill for Network Computing, Inc., Netlabs, Inc. and Creative Interaction Technologies, Inc. because less than 5% of the original assembled workforces remained. RESTRUCTURING. Restructuring charges were $2,524,000 in 1997, representing 1% of total revenues. The restructuring charges were incurred as a result of reorganizations and closures within the Network & Storage Management Group unit for the reduction of personnel, write-off or write-down of equipment, intangibles and other assets, closure of duplicate facilities, fees for legal and accounting services, contract cancellations and other related expenses. UNUSUAL ITEMS. Unusual items of $13,446,000 were recognized during 1997, representing 6% of total revenues. In connection with the June 1996 acquisition of Holistic, $18,000,000 of funds were placed in escrow pending the outcome of certain purchase price contingencies. Prior to the expiration of the contingency period, Seagate Software elected to release the funds to the Holistic shareholders even though certain contingencies had not been met. Of the $18,000,000 total contingency payment, the Company recorded $13,446,000 as compensation expense for amounts paid to former Holistic shareholders who were employees of Seagate Software and recorded the remaining $4,554,000 paid to non-employee shareholders as additional purchase price. Seagate Software released the funds prior to the expiration of the contingency period, because in order to position the Information Management Group business unit for future growth and product development, Seagate Software needed to begin an aggressive plan to integrate the operations of Holistic. These activities resulted in the diversion of the attention of certain Holistic employees from their responsibilities at Holistic. As such, Holistic's ability to achieve the purchase price contingencies necessary to trigger the $18,000,000 contingency payment was impaired. Seagate Software believed that the Holistic employees should not be penalized, because they had sacrificed achievement of their individual goals in order to meet the overall needs of Seagate Software. Accordingly, Seagate Software elected to make the full payment of $18,000,000. INTEREST AND OTHER, NET. Total interest and other, net decreased to a net expense of $10,000 in 1998 from a net expense of $2,381,000 in 1997, representing 0% and 1% of total revenues, respectively. The decrease in interest and other, net was primarily due to lower interest expense on a lower level of outstanding borrowings from Seagate Technology and an increase in foreign exchange gains. INCOME TAXES. Seagate Software recorded a $15,385,000 provision for income taxes at an effective rate of 252% in 1998 compared with a $8,714,000 benefit from income taxes at an effective rate of 14% for 1997. The effective rate used to record the provision for income taxes in 1998 was greater than the statutory rate primarily due to foreign tax rates that were in excess of the U.S. statutory tax rate, increases in the valuation allowance for deferred tax assets and goodwill amortization for certain acquisitions that were not deductible for tax purposes. The effective rate used to record the benefit from income taxes in 1997 was less than the statutory rate primarily due to increases in the valuation allowance for deferred tax assets and goodwill amortization for certain acquisitions that were not deductible for tax purposes. FISCAL YEAR 1997 VERSUS FISCAL YEAR 1996 REVENUES. Total revenues increased 53% to $216,950,000 in 1997 from $141,586,000 in 1996. The increase in licensing revenues was due in part to growth in the market for business intelligence and information technology infrastructure management software products and related services, expansion of Seagate Software's European distribution channels and market demand for Network & Storage Management Group's Seagate Backup Exec, a storage management product that supports Microsoft's Windows NT operating system. The increase in maintenance, support and other revenues was due in part to higher training and consulting revenues resulting from a larger customer base. Additionally, the 1997 results included a full year of operations for the 1996 acquisitions of OnDemand Software, Inc. ("OnDemand") and Holistic. These 1996 acquisitions accounted for increases in licensing, licensing from Seagate Technology and maintenance, support 16 18 and other revenues of approximately $26,039,000, $842,000 and $14,758,000, respectively, in 1997 as compared with 1996. During 1997 Seagate Software generated export revenues from the United States of approximately $44,129,000. Revenues and expenses from Seagate Software's operations outside of the Americas were approximately $18,896,000 and $23,938,000, respectively, as translated to the U.S. dollar from foreign currencies. The principal currency for such operations is the British pound. COST OF REVENUES. The cost of revenues increased to $47,789,000 in 1997 from $29,019,000 in 1996, representing 22% and 20% of total revenues, respectively. The majority of the increase in absolute dollars was due to an increase in the amortization of acquired developed technology due to a higher level of intangible assets and an increase in the Information Management Group's costs related to service revenues and related costs resulting from the inclusion of a full year of operations in 1997 of the 1996 acquisition of Holistic. Additionally, in 1997 Seagate Software wrote off and wrote down certain developed technologies amounting to approximately $6,918,000 as a result of asset values that had become impaired based on Seagate Software's phasing out of certain products. In 1997, the unamortized software costs for developed technology were reviewed under the guidance of SFAS No. 86 for potential impairment. Seagate Software compared the net realizable value on a product by product basis to the unamortized costs including goodwill. Impairments were caused by a number of factors including Seagate Software's business decision to stop selling technologies such as DOS, new acquisitions, or new product designs. Additionally in 1997, Seagate Software incurred a write-off related to the decision to close down and sell one of its acquisitions, Calypso Software Systems, Inc. The write-off was to the expected net realizable value. SALES AND MARKETING. Sales and marketing costs increased to $107,706,000 in 1997 from $71,129,000 in 1996, representing 50% of total revenues in both periods. The increase in absolute dollars was due to increased personnel, advertising and promotion costs necessary to support revenue growth and the expansion of Seagate Software's European distribution channel. Additionally, the 1997 results included a full year of operations for Seagate Software's 1996 acquisitions compared with a partial year of operations in 1996. RESEARCH AND DEVELOPMENT. Research and development expenses increased to $42,842,000 in 1997 from $36,897,000 in 1996, representing 20% and 26% of total revenues, respectively. The increase in absolute dollars was primarily due to increases in personnel and related expenses, new product development and localization costs, partially offset by facility consolidations and reductions in workforce within the Network & Storage Management Group business unit. Additionally, the 1997 results included a full year of operations for Seagate Software's 1996 acquisitions compared with a partial year of operations in 1996. GENERAL AND ADMINISTRATIVE. Total general and administrative expenses increased to $36,861,000 in 1997 from $22,852,000 in 1996, representing 17% and 16% of total revenues, respectively. The increase in absolute dollars was primarily due to increases in personnel and related expenses and increases in corporate administrative expenses and information systems necessary to support Seagate Software's growth. Additionally, the 1997 results included a full year of operations for Seagate Software's 1996 acquisitions compared with a partial year of operations in 1996. WRITE-OFF OF IN-PROCESS RESEARCH AND DEVELOPMENT. During 1997, total write-offs of in-process research and development were $2,613,000. Seagate Software incurred this charge in connection with additional amounts paid with respect to the June 1996 acquisition of Holistic. During 1996, total write-offs of in-process research and development were $96,958,000, which resulted from Seagate Software's 1996 acquisitions. AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. Amortization of goodwill and other intangibles increased to $23,465,000 in 1997 from $13,035,000 in 1996, representing 11% and 9% of total revenues, respectively. The increase in absolute dollars was primarily due to increased amortization expense on a higher level of intangible assets and write-downs and write-offs of the carrying value of goodwill and other intangible assets of approximately $10,259,000 based on shortfalls of estimated future cash flows. 17 19 Long-lived assets other than developed technology, including associated goodwill, are assessed for impairment under the guidance of Statement of Financial Accounting Standards Board No. 121 ("SFAS 121"), and any write-offs or write-downs are included in amortization of goodwill and other intangibles. Goodwill not within the scope of SFAS 121 is assessed for impairment under the guidance of Accounting Principals Board No. 17, and any write-downs or write-offs are also included in amortization of goodwill and other intangibles. Developed technology acquired in business combinations is assessed for impairment under the guidance of Statement of Financial Accounting Standards Board No. 86, and any related write-offs or write-downs are included in costs of revenues. During 1997 and 1996, Seagate Software recorded impairment charges for write-off and write-downs of acquired intangible assets and goodwill, exclusive of amounts relating to developed technology included in costs of revenues, as follows: In 1997, Seagate Software determined that it would abandon and discontinue selling substantially all of the current and future products and technologies obtained from the 1994 acquisition of Palindrome Corporation in favor of selling and supporting the current and future products and technologies obtained from the 1996 acquisition of Arcada Holdings, Inc. Additionally, in 1997, Seagate Software decided to close down and sell Calypso Software Systems, Inc. and to abandon and discontinue sales of the developed and future products and technologies acquired from Frye Computer Systems, Inc. In connection with these determinations, Seagate Software recorded write-offs and write-downs of goodwill amounting to approximately $6.2 million. In 1996, the former owner of Frye Computer Systems, Inc., a 1995 acquisition, Mr. Frye, left Seagate Software. With his departure, Seagate Software decided to release Mr. Frye from his remaining non-compete period and to not use the Frye name trademark in future periods. As a result, the remaining carrying value of the intangible assets relating to the covenant not to compete and the trademark, and associated goodwill, totaling $2.2 million were written off in their entirety. Seagate Software is not currently generating revenue from any products for which the related developed technology has been impaired. RESTRUCTURING. Restructuring charges were $9.5 million in fiscal 1996 and $2.5 million in fiscal 1997. The 1996 restructuring charges pertain to the acquisition of Arcada Holdings, Inc. in February 1996. As a result of the acquisition, Seagate Software had obtained duplicate technologies and product lines in data protection and storage management software as those assets acquired in the Palindrome Corporation (Palindrome) acquisition in fiscal 1995. Seagate Software determined that it would be beneficial to consolidate the world-wide sales, marketing, research and development, technical support and other operations and administrative functions of its network and storage management business. A restructuring plan was approved by the Board of Directors in March 1996 and the plan resulted in facility closures and staff reductions of 43 at the Arcada facilities in Westboro, Massachusetts, the United Kingdom and France, as well as staff reductions of 69 at the former Palindrome facility in Naperville, Illinois. In addition, because Arcada had a better industry reputation and superior products to those of Palindrome, Seagate Software's plan and strategy going forward was to focus on the technologies and products acquired from Arcada. The revenue and net operating loss relating to products acquired from Palindrome for fiscal 1996 was $15.9 million and $2.1 million respectively. For fiscal 1997, the revenue and net operating loss relating to products acquired from Palindrome was $3.3 million and $3.7 million respectively. The non-cash restructuring charges included amounts for abandonment of the Palindrome trademarks, impairment of the capitalized workforce intangible assets pertaining to the acquisition of Palindrome because of the planned layoff of personnel, write-off of a duplicate trade show booth, and write-off of obsolete Palindrome marketing materials. Cash restructuring charges included amounts for severance and benefits to terminated Palindrome employees, costs for facilities lease termination, other contract cancellation fees, and merger related costs incurred by Arcada in the acquisition of the Arcada minority interests by Seagate Technology. The fiscal 1997 restructuring charges netted to $2.5 million, comprised of a $3.4 million restructuring charge that included the closure of the Network & Storage Management Group's facility located in Cupertino, California. This facility closure resulted in cash charges for severance and benefits for 69 employee terminations and non-charges for excess facilities and the write down of equipment. In addition, the 18 20 $3.4 million included amounts related to Seagate Software's decision, after concluding a sale was no longer viable, to no longer pursue the technologies acquired in the 1996 acquisition of Calypso Software Systems, Inc. (Calypso) and to shutdown its operations. This decision resulted in cash charges for severance and benefits for 35 employee terminations and non-cash charges for the write off of certain remaining intangible assets of Calypso. The revenue and net operating loss relating to Calypso for fiscal 1996 was $444,000 and $53,000 respectively. For fiscal 1997, the revenue and net operating loss relating to Calypso was $640,000 and $47,000 respectively. The restructuring charges recorded in fiscal 1997 were reduced by $957,000 for the reversal of amounts pertaining to the fiscal 1996 restructuring charges as a result of a higher than planned number of voluntary employee terminations without severance benefits prior to the facility shutdown and completion of other aspects of the restructuring plan at less than the originally estimated cost, net of an increase in the accrual for facilities lease payments due to changes in estimates of the costs to terminate leases after facilities closure. A summary of Seagate Software's restructuring activities for fiscal years 1996, 1997 and 1998, and the first six months of fiscal 1999 is provided below (in thousands): SEVERANCE AND CONTRACT LEGAL AND EMPLOYEE CANCELLATION ACCOUNTING OTHER BENEFITS FACILITIES EQUIPMENT INVENTORY INTANGIBLES FEES FEES EXPENSES --------- ---------- --------- --------- ----------- ------------ ---------- -------- 1996 charges......... $1,554 $1,571 $ 1,018 $ 300 $ 4,312 $ 67 $ 525 $ 155 Cash charges......... (518) -- -- -- -- -- (568) -- Non-cash charges..... -- (121) (116) -- (4,052) -- -- (138) ------ ------ ------- ----- ------- ---- ----- ----- Reserves 1996........ 1,036 1,450 902 300 260 67 (43) 17 1997 charges......... 770 505 728 -- 1,378 -- -- 100 Cash charges......... (975) (915) -- -- -- -- -- -- Non-cash charges..... -- (72) (44) -- (1,378) -- -- -- Adjustment........... (351) 267 (172) (300) (260) (67) 43 (117) ------ ------ ------- ----- ------- ---- ----- ----- Reserves 1997........ 480 1,235 1,414 -- -- -- -- -- Cash charges......... (373) (519) (9) -- -- -- -- -- Non-cash charges..... -- -- (1,045) -- -- -- -- -- Adjustment........... (107) 467 (360) -- -- -- -- -- ------ ------ ------- ----- ------- ---- ----- ----- Reserves 1998........ -- 1,183 -- -- -- -- -- -- Cash charges (unaudited)........ -- (251) -- -- -- -- -- -- ------ ------ ------- ----- ------- ---- ----- ----- Balance 1/1/99 (unaudited)........ $ -- $ 932 $ -- $ -- $ -- $ -- $ -- $ -- ====== ====== ======= ===== ======= ==== ===== ===== TOTAL ------- 1996 charges......... $ 9,502 Cash charges......... (1,086) Non-cash charges..... (4,427) ------- Reserves 1996........ 3,989 1997 charges......... 3,481 Cash charges......... (1,890) Non-cash charges..... (1,494) Adjustment........... (957) ------- Reserves 1997........ 3,129 Cash charges......... (901) Non-cash charges..... (1,045) Adjustment........... -- ------- Reserves 1998........ 1,183 Cash charges (unaudited)........ (251) ------- Balance 1/1/99 (unaudited)........ $ 932 ======= Seagate Software's remaining restructuring reserves pertain to continuing lease payments on facilities that were closed and abandoned as a result of the Palindrome restructuring. Seagate Software has been unable to sublease these facilities and anticipates that the remaining restructuring reserves will be utilized over the period through lease termination in fiscal 2002. In fiscal 1996, Seagate Software recorded a restructuring reserve of $9,502,000 for the following items: Severance and employee benefits ($1,554,000) -- Severance and employee benefits included amounts for consolidation of operations and termination of employees at the Arcada facilities in Westboro, Massachusetts, the United Kingdom and France, as well as at the former Palindrome facility in Naperville, Illinois. Excess facilities ($1,571,000) -- This accrual was designed to provide for rent termination costs and rent expense for facilities located in Naperville, Westboro, the United Kingdom and France that are to be closed as a result of the restructuring actions. Equipment ($1,018,000) -- This amount is a reserve for equipment at the Naperville, Westboro, the United Kingdom and France facilities. It consists of computer equipment, furniture and fixtures and software at these facilities that will not be used after the locations are closed. All of the equipment provided for in this reserve has been abandoned. 19 21 Inventory ($300,000) -- This consists of obsolete packaging material that will no longer be used and OEM inventory of $80,000 that will no longer be sold. Intangibles ($4,312,000) -- This write down consists of Palindrome intangible assets of $3,534,000, $390,000 of developed technology related to Atlas and $388,000 of goodwill related to the Sytron acquisition. The Palindrome intangible assets were further broken down into trademark of $1,000,000, workforce of $1,188,000, distribution network of $69,000 and goodwill of $1,277,000. Seagate Software decided to pursue the Arcada brand name and trademark and abandon the Palindrome trademark. As a result, Seagate Software determined that it would lay off substantially all of the 121 employees of Palindrome located at the Naperville facility. At the time of original purchase, Seagate Software proportionally allocated goodwill to long-lived intangible assets based upon the original purchase price. The amounts of goodwill included in the restructuring reserve relate to the remaining unamortized goodwill associated with the intangible assets written off. Contract Cancellation ($67,000) -- This $67,000 item is a canceled contract for outsourced Technical Support with a vendor used by Palindrome. Legal/Accounting Fees ($525,000) -- This $525,000 represents and estimate of the legal and accounting fees that were to be incurred by Arcada from the acquisition of Arcada stock by Seagate Technology. Other ($155,000) -- This represents a trade show booth valued at $100,000 that is redundant and $55,000 worth of obsolete marketing materials. The above assets were not impaired in a prior period because their impairment arose specifically from the restructuring actions taken as a result of the acquisition of the minority interest in Arcada in the third quarter of fiscal 1996. Prior to the acquisition, Palindrome products were marketed and sold as part of the Seagate Software portfolio. Seagate Software has not generated any income from these activities in subsequent periods. In fiscal 1997, Seagate Software recorded an additional restructuring reserve of $3,481,000 that resulted primarily from the plan to shutdown Manchester operations and the decision to try to sell the Calypso technology and a separate decision to consolidate NSMG operations which resulted in the shutdown of Seagate Software's facility in Cupertino, California. Severance and employee benefits ($770,000) -- Severance and employee benefits included amounts for the shutdown and termination of employees at the Cupertino, California facility due to a consolidation of operations and the shutdown and termination of employees at the Calypso facility in Manchester, New Hampshire due to a decision to no longer pursue the Calypso products and technologies. Excess facilities ($505,000) -- This accrual was designed to provide for rent termination costs and rent expense for facilities closures in Manchester, New Hampshire and Cupertino, California. Equipment ($728,000) -- This equipment is in the Manchester and Cupertino facilities that would not be used after the shutdowns. It consisted of largely of computer equipment but also included amounts for furniture and fixtures and software. All of the equipment provided for in this reserve has been abandoned. Intangibles ($1,378,000) -- This asset consisted of Calypso related intangibles first capitalized upon the acquisition of Calypso in fiscal 1996. The amounts written down included net developed technology of $1,086,000 and assembled workforce of $292,000. These assets were written down based on management's plan to sell Calypso and its products and technologies. Other ($100,000) -- This represents miscellaneous additional costs related to the Manchester (Calypso) shutdown. The above assets were not impaired in a period prior to recording the restructuring reserves because their impairment arose specifically from the business decision and plan in the fourth quarter of fiscal 1997 to close the Manchester (Calypso) facility and abandon that technology and the additional decision to consolidate operations of the company and close the Cupertino facility. 20 22 UNUSUAL ITEMS. In connection with the June 1996 acquisition of Holistic, Seagate Software recorded $13,446,000 in fiscal 1997, representing 6% of total revenues, as compensation expense for amounts paid to former Holistic shareholders who were employees of Seagate Software. INTEREST AND OTHER, NET. Total interest and other, net increased to a net expense of $2,381,000 in 1997 from a net expense of $610,000 in 1996, representing 1% and 0% of total revenues, respectively. The increase in interest and other, net was primarily due to higher interest expense on a higher level of outstanding borrowings from Seagate Technology. INCOME TAXES. Seagate Software recorded a $8,714,000 benefit from income taxes at an effective rate of 14% in 1997 compared with a $8,748,000 benefit from income taxes at an effective rate of 6% for 1996. The effective rate used to record the benefit from income taxes in each fiscal year was less than the statutory rate primarily due to increases in the valuation allowance for deferred tax assets and charges in 1996 for in-process research and development for certain acquisitions that were not deductible for tax purposes. LIQUIDITY AND CAPITAL RESOURCES Seagate Software's total cash was $15,130,000 and $12,085,000 as of July 3, 1998 and June 27, 1997, respectively. The increase in cash was primarily due to loan borrowings from the parent company of $261.9 million, cash provided by operating activities and the sale of common stock under the Option Plan, partially offset by a reduction in the Company's loan repayments to the parent company of $274.8 million, acquisition of a business, purchases of property and equipment and purchases of intangible assets. The Company's cash is maintained in highly liquid operating accounts and primarily consists of bank deposits. Seagate Software's operations have been financed by cash flows from operating activities and borrowings from Seagate Technology. Such borrowings are available to Seagate Software under a Revolving Loan Agreement, between Seagate Software and Seagate Technology, which was renewed on July 4, 1998 on substantially the same terms and conditions as the prior agreement which was dated June 28, 1996. Under the Revolving Loan Agreement, Seagate Technology finances certain of Seagate Software's working capital requirements. The Revolving Loan Agreement, which provides for maximum borrowings of up to $60,000,000, is renewable every two years and expires on July 3, 2000. Beginning in fiscal year 1999, the Company will pay interest at the LIBOR rate plus 2% per annum on such borrowings; the Company previously paid interest at 6%. The loan balance was $16,054,000 as of July 3, 1998. In addition to the Revolving Loan Agreement with Seagate Technology, certain foreign subsidiaries have line of credit facilities with third party financial institutions. These line of credit facilities provide for additional borrowings of up to an equivalent of approximately $1,100,000 at July 3, 1998. Interest rates payable on borrowings are based on local bank prime interest rates. At July 3, 1998, there were no outstanding borrowings under any of these lines of credit. During the year ended July 3, 1998, Seagate Software made investments in property and equipment totaling approximately $10,387,000 for new office facilities, leasehold improvements, computers, furniture and office equipment. Seagate Software presently anticipates it will make investments in 1999 of approximately $15,000,000 in property and equipment.* Additionally, product development activities may include cash used to acquire technology.* Seagate Software expects that such investments will be funded from existing cash balances and cash flows from operations.* Seagate Software believes its current cash balances, its available borrowings from Seagate Technology and cash flows generated from Seagate Software's operations will be sufficient to meet its anticipated cash needs for working capital and capital expenditures for at least the next 12 months.* Furthermore, Seagate Software anticipates that future operating and investing activities may be financed by additional borrowings - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Readers are cautioned that other sections and other sentences not so identified may also contain forward-looking information. 21 23 from Seagate Technology, equity financing or other sources.* Seagate Software believes that additional financing from Seagate Technology will be available at a reasonable cost.* NEW ACCOUNTING PRONOUNCEMENTS In October 1997 and March 1998, the American Institute of Certified Public Accountants issued Statements of Position 97-2, "Software Revenue Recognition" ("SOP 97-2") and 98-4, "Deferral of the Effective Date of a Provision of SOP 97-2, Software Revenue Recognition" ("SOP 98-4"), which the Company currently is required to adopt for transactions entered into after July 3, 1998. SOP 97-2 and SOP 98-4 provide guidance on recognizing revenue on software transactions and supersede SOP 91-1. The Company has assessed the impact of the requirements of SOP 97-2 and SOP 98-4 and has changed certain of its policies and procedures. The Company believes that the adoption of SOP 97-2 and SOP 98-4 will not have a significant impact on the Company's revenues or results of operations. The Company intends to adopt Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130") and No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131") during fiscal 1999. Both standards will require additional disclosure, but will not have a material effect on the Company's financial position or results of operations.* SFAS 130 establishes standards for the reporting and display of comprehensive income and is expected to first be reflected in the Company's first quarter of 1999 interim financial statements. The components of comprehensive income include net income and items that are currently reported directly as a component of shareholders' equity such as changes in foreign currency translation adjustments and changes in the fair value of available-for-sale financial instruments. SFAS 131 changes the way companies report segment information and requires segments to be determined based on how management measures performance and makes decisions about allocating resources. SFAS 131 will first be reflected in the Company's 1999 Annual Report on Form 10-K. In April 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 provides guidance on capitalization of the costs incurred for computer software developed or obtained for internal use. It also provides guidance for determining whether computer software is internal-use software and on accounting for the proceeds of computer software originally developed or obtained for internal use and then subsequently sold to the public. The Company has not yet determined the impact, if any, of adopting this statement. The disclosures prescribed by SOP 98-1 will be effective for the Company's consolidated financial statements for the fiscal year ending June 30, 2000. FACTORS AFFECTING FUTURE OPERATING RESULTS POTENTIAL FLUCTUATIONS IN ANNUAL AND/OR QUARTERLY OPERATING RESULTS. The Company's future results of operations may be subject to substantial fluctuations.* The Company operates with no backlog because its software products are generally shipped shortly after orders are received. Annual and/or quarterly sales and operating results therefore depend on the volume and timing of and the ability to fill orders received within a given quarter, and such factors are difficult to forecast.* The Company recognizes a substantial portion of its revenue in the last month of each quarter and, therefore, may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall.* If revenue levels in a given year or quarter are below expectations, the Company's operating results may be materially adversely affected.* The Company expects to experience significant fluctuations in annual and/or quarterly operating results based upon a number of factors including, but not limited to, (i) market acceptance of new products and product enhancements, (ii) the Company's ability to develop, introduce and market new products and product enhancements in a timely fashion, (iii) the timing of large orders, (iv) increased competition, (v) changes in - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Readers are cautioned that other sections and other sentences not so identified may also contain forward-looking information. 22 24 pricing policies by the Company and/or its competitors, (vi) the Company's ability to control costs, (vii) the amount of one-time charges incurred in future acquisitions, (viii) the Company's ability to integrate future acquisitions into its operations, (ix) technological changes in the Company's markets, (x) personnel changes and (xi) general economic factors.* Because of these considerations, the Company believes that a period-to-period comparison of its operations is not necessarily meaningful and should not be relied upon as any indication of future performance. REVENUE CONCENTRATION. The Company derives a substantial majority of its revenues from a limited number of software products and anticipates that revenue from these products will continue to account for a majority of the Company's revenues in the foreseeable future.* Broad market acceptance of such products is therefore critical to the Company's future success, and failure to achieve broad market acceptance of these products as a result of competition, technological change or other factors would have a material adverse effect on the business, operating results and financial condition of the Company.* The life cycle of these products is difficult to estimate, and the Company's future financial performance may depend in part on the successful development, introduction and market acceptance of new products, applications and product enhancements.* There can be no assurance that the Company will continue to be successful in marketing its key products or any new products, applications or product enhancements. Further, the Company derived 22% of its revenues from sales to its top customer, Ingram Micro Inc., in 1998. A significant reduction in orders from this customer, if not offset by increased sales to other customers, could have a material adverse effect on the Company's business, operating results, or financial condition.* Accordingly, there can be no assurance that the Company will continue to be successful in marketing its products to such customer. NEW PRODUCT DEVELOPMENT AND TECHNOLOGICAL CHANGE. The markets for the Company's products are characterized by rapidly changing technology, changing customer needs, evolving industry standards and frequent new product introductions. The Company's future success will therefore depend on its ability to design, develop, test and support new software products and enhancements on a timely and cost effective basis.* There can be no assurance that the Company will be successful in developing and marketing new products that respond to technological changes and changing customer needs, or that the Company's new products will achieve market acceptance. If the Company is unable for technological or other reasons to develop and introduce new products in a timely manner in response to changing market conditions or customer requirements, the Company's business, operating results or financial condition could be materially adversely affected. If potential new products are delayed or fail to achieve market acceptance, the Company's business, operating results and financial condition would be materially adversely affected. In addition, significant order deferrals due to customers waiting for the introduction of new or announced products could have a material adverse effect on the Company's business, operating results or financial condition. RELIANCE ON SALES STAFF AND CHANNEL PARTNERS. The Company sells and supports its products through its sales staff and third party distributors and OEMs. In particular, the Company has a strategic relationship with Microsoft pursuant to which (i) the Company's products are bundled with Microsoft's products and (ii) the Company has in the past and is currently participating in the development of certain utilities and products for inclusion in Microsoft's products. Any material diminution in the level and breadth of activities with Microsoft could have a material adverse effect on the Company's business, operating results or financial condition. The Company has made significant expenditures in recent years for the expansion of its sales and marketing force and plans to continue to expand its sales and marketing force.* The Company's future success will depend in part upon the productivity of its sales and marketing force and the ability of the Company to continue to attract, integrate, train, motivate and retain new sales and marketing personnel.* Competition for sales and marketing personnel in the software industry is intense. There can be no assurance that the Company will be successful in hiring and retaining such personnel in accordance with its plans. There can be no assurance that the Company's recent and other planned expenses in sales and marketing will ultimately prove to be successful - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Readers are cautioned that other sections and other sentences not so identified may also contain forward-looking information. 23 25 or that the incremental revenue generated will exceed the significant incremental costs associated with these efforts. In addition, there can be no assurance that the Company's sales and marketing organization will be able to compete successfully against the significantly more extensive and better funded sales and marketing operations of many of the Company's current and potential competitors. If the Company is unable to develop and manage its sales and marketing force expansion effectively, the Company's business, operating results and financial condition would be materially adversely affected. The Company derives a substantial portion of its revenue from the marketing and distribution of its products by its distributors and OEMs. The Company's agreements with distributors and OEMs typically allow such resellers to carry product lines that are competitive with those of the Company and in many cases may be terminated by either party without cause. There can be no assurance that such distributors and OEMs will place high priority on the marketing of the Company's products or that they will continue to carry the Company's products. Loss of the Company's current distributors and OEMs or the inability to attract new distributors and OEMs could materially adversely affect the Company's business, operating results or financial condition. COMPETITION. The markets for the Company's products are highly competitive and characterized by rapidly changing technology and evolving standards. The Company expects additional competition from other established and/or emerging companies and as a result of future software industry consolidations.* Increased competition can be expected to cause price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on the Company's business, operating results or financial condition. Current and potential competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, promotion, sale and support of their products than the Company.* It is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. In addition, network operating system vendors could introduce new or upgrade existing operating systems or environments that could render the Company's products obsolete and unmarketable. There can be no assurance that the Company will successfully compete against current or future competitors, or that competitive pressures faced by the Company will not materially adversely affect its business, operating results or financial condition. DEPENDENCE ON KEY PERSONNEL. The Company's future performance depends to a significant degree upon the continued service of its key members of management as well as marketing, sales and product development personnel.* The loss of one or more of the Company's key personnel would have a material adverse effect on the Company's business, operating results and financial condition. The Company believes its future success will also depend in large part upon its ability to attract and retain highly skilled management, marketing, sales and product development personnel.* Competition for such personnel is intense, and there can be no assurance that the Company will be able to retain its key employees or that it will be successful in attracting, assimilating and retaining them in the future. MANAGEMENT OF GROWTH. The Company is in the process of expanding the geographic scope of its customer base and operations. This expansion has resulted and will continue to result in substantial demands on the Company's management resources.* The Company's future operating results will depend on the ability of its officers and other key employees to continue to implement and improve its operations, customer support and financial control systems and to effectively expand, train and manage its employee base. RISK OF ACQUISITIONS. The Company has acquired numerous businesses and intends to enter into future business combinations and acquisitions of complementary companies, products and technologies. There can, however, be no assurance that suitable companies, divisions or products will be available for acquisition.* Such acquisitions are inherently subject to certain risks, including the difficulty of assimilating the operations and personnel of the combined companies, the potential disruption of the Company's ongoing business, the - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Readers are cautioned that other sections and other sentences not so identified may also contain forward-looking information. 24 26 potential inability to retain key technical and managerial personnel, additional expenses associated with the amortization of acquired intangible assets, and the potential impairment of relationships with employees and customers as a result of any integration of new personnel. There can be no assurance that the Company will be successful in overcoming these risks or that such transactions will not have a material adverse effect upon the Company's business, financial condition or results of operations. RISKS OF INFRINGEMENT. The Company's success depends to a substantial degree on its proprietary technology. The Company relies on a combination of patent, copyright, trademark and trade secret rights, confidentiality procedures, employee and third party nondisclosure agreements and licensing arrangements to protect its proprietary rights. As part of its confidentiality procedures, the Company enters into license agreements with respect to its software, documentation and other proprietary information. In licensing its products, the Company relies in part on shrink wrap licenses that are not signed by the end user and, therefore, may be unenforceable under the laws of certain jurisdictions. Despite the precautions undertaken by the Company, it may be possible for a third party to copy or otherwise obtain and use the Company's products and technology without authorization. Policing unauthorized use of the Company's products is difficult and, although the Company is unable to determine the extent to which piracy of its software products exists, software piracy can be expected to be a persistent problem.* PROTECTION OF INTELLECTUAL PROPERTY. No assurance can be given that competitors will not successfully challenge the validity or scope of the Company's patents, copyrights and trademarks and that such patents, copyrights and trademarks will provide a competitive advantage to the Company. As part of its confidentiality procedures, the Company generally enters into non-disclosure agreements with its employees, distributors and corporate partners, and license agreements with respect to its software documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use the Company's products or technology without authorization or to develop similar technology independently. Effective protection of intellectual property rights is unavailable or limited in certain foreign countries. There can be no assurance that the Company's protection of its proprietary rights will be adequate or that the Company's competitors will not independently develop similar technology, duplicate the Company's products or design around any patents issued to the Company or other intellectual property rights of the Company. The Company is not aware that any of its products infringe upon the proprietary rights of third parties. There can be no assurance, however, that third parties will not claim such infringement by the Company with respect to current or future products. The Company believes that software product developers will be increasingly subject to claims of infringement as the number of products and competitors in the Company's industry segment grows and the functionality of products in the industry segment overlaps.* Any such claims, with or without merit, could result in costly litigation that could absorb significant management time, which could have a material adverse effect on the Company's business, operating results or financial condition.* Such claims might require the Company to enter into royalty or license agreements. Such royalty or license agreements, if required, may not be available on terms acceptable to the Company or at all, and the Company's inability to enter such agreements could have a material adverse effect on the Company's business, operating results or financial condition. PRODUCT LIABILITY. The Company markets its products to customers for information technology system management and resource optimization and to access, analyze, report and deliver enterprise data. The Company's license agreements with its customers typically contain provisions designed to limit the Company's exposure to potential product liability claims. It is possible, however, that the limitation of liability provisions contained in the Company's license agreements may not be effective as a result of existing or future federal, state or local laws or ordinances or unfavorable judicial decisions. The sale and support of its products by the Company may entail the risk of such claims, which could be substantial in light of the use of such products in - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Readers are cautioned that other sections and other sentences not so identified may also contain forward-looking information. 25 27 system management, resource optimization and BI applications. A successful product liability claim brought against the Company could have a material adverse effect upon the Company's business, operating results or financial condition. POTENTIAL LITIGATION/LIABILITY RELATED TO YEAR 2000 READINESS. It is likely that, commencing in the Year 2000, the functionality of certain operating environments will be adversely affected when one or more component products of the environment is unable to process four-digit characters representing years.* This could result in a system failure or miscalculation causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in normal business activities. The Year 2000 problem is pervasive and complex as virtually every computer operation will be affected in some way by the rollover of the two-digit year value to 00. The Company's products are used in numerous operating environments. The Company considers a product Year 2000 ready if the product's performance and functionality are unaffected by processing dates prior to, during, and after the Year 2000, but only if all products (for example hardware, firmware, and software) used with the product properly exchange accurate date data with it. The Company has determined that certain of its software products are not and will not be Year 2000 ready and is taking measures to inform its customers of that fact. The inability of one or more of the Company's products to properly manage and manipulate data related to the Year 2000 could result in a material adverse effect on the Company's business, financial condition or results of operations, including increased warranty costs, customer satisfaction issues and potential lawsuits. Even if the Company successfully brings certain of its products into Year 2000 readiness and publicizes the non-readiness of its other products, the Company anticipates that substantial litigation may be brought against vendors of all component products of noncompliant operating environments, including the Company.* The Company's agreements with its customers typically contain provisions designed to limit the Company's liability for such claims. It is possible, however, that these measures will not provide protection from liability claims, as a result of existing or future federal, state or local laws or ordinances or unfavorable judicial decisions. The Company believes that any such claims, with or without merit, could result in costly litigation (and possible adverse judgment) that could absorb significant management and product development time and potentially result in significant liability to the Company, which could have a material adverse effect on the Company's business, operating results or financial condition.* The Company has initiated a program to address Year 2000 readiness in its internal systems. It has also initiated communications with its large suppliers and customers to determine the extent to which the Company is vulnerable to those third parties' failure to remediate their own Year 2000 issues. The Company is still in the process of conducting its Year 2000 audit and therefore is unable to make a reasonable estimate of the costs associated with Year 2000 readiness. Accordingly, no assurance can be given that the costs required to address the Year 2000 issue will not have a material adverse effect on the Company's business, financial condition or results of operations. Assessment and remediation are proceeding in tandem, and the Company intends to have its critical internal systems in Year 2000 compliance by July 3, 1999.* These activities are intended to encompass all major categories of systems in use by the Company, including manufacturing, engineering, sales, finance and human resources. The costs incurred to date related to these programs have not been and are not expected to be material.* While the Company currently expects that the Year 2000 issue will not pose significant operational problems, delays in the implementation of new information systems, or a failure to fully identify all Year 2000 dependencies in the Company's systems and in the systems of its suppliers, customers and financial institutions could have material adverse consequences, including delays in the delivery or sale of products.* - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Readers are cautioned that other sections and other sentences not so identified may also contain forward-looking information. 26 28 Therefore, the Company is developing contingency plans for continuing operations in the event such problems arise. The Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues as companies expend significant resources to correct or patch their current software systems for Year 2000 readiness.* These expenditures may result in reduced funds available to purchase products such as those offered by the Company, which could have a material adverse effect on the Company's business, operating results or financial condition.* SOFTWARE PRODUCT ERRORS OR DEFECTS. Software products as complex as those offered by the Company frequently contain errors or defects, especially when first introduced or when new versions or enhancements are released. Despite product testing, the Company's recently introduced products or any products may contain defects or software errors and, as a result, the Company may experience delayed or lost revenues during the period required to correct any defects or errors.* Any such defects or errors could result in adverse customer reactions, negative publicity regarding the Company and its products, harm to the Company's reputation or loss of or delay in market acceptance, or could require extensive product changes, any of which could have a material adverse effect upon the Company's business, operating results or financial condition. RISK OF INTERNATIONAL SALES. The Company's international business involves a number of risks, including lack of acceptance of localized products, cultural differences in the conduct of business, longer accounts receivable payment cycles, greater difficulty in accounts receivable collection, seasonality due to the slow down in European business activity during the summer months, unexpected changes in regulatory requirements, royalties and withholding taxes that restrict repatriation of earnings, tariffs and other trade barriers, difficulty in hiring qualified personnel, economic and political conditions in each country, management of an enterprise spread over various countries, the burden of complying with a wide variety of foreign laws and an increase in international competition. A majority of the Company's international sales are currently denominated in U.S. dollars, and an increase in the value of the U.S. dollar relative to foreign currencies could make the Company's products more expensive and potentially less competitive in foreign markets. There can be no assurance that such factors will not have a material adverse effect on the Company's future international sales and therefore the overall operating results and financial condition of the Company. The Company continues to expand its international operations, which requires significant management attention and financial resources and could materially adversely affect the Company's operating results. To the extent the Company is unable to effect this expansion in a timely manner, the Company growth, if any, in international sales will be limited and the Company's business, operating results or financial condition could be materially adversely affected. The Company anticipates that the recent deterioration of the underlying economic conditions in certain Asian countries may have an impact on its sales to customers or OEMs located in those countries due to the impact of currency fluctuations on the relative price of the Company's products and/or restrictions on government spending imposed by the International Monetary Fund (the "IMF") on those countries receiving the IMF's assistance.* In addition, customers in those countries may face reduced access to working capital to fund component purchases, such as the Company's products, due to higher interest rates, reduced bank lending due to contractions in the money supply or the deterioration in the customer's or its bank's financial condition or the inability to access local equity financing. During fiscal 1998, sales to OEMs or end-user customers located in or to OEMs whose end customers were located in the countries of Japan, Korea, Malaysia, Thailand, Taiwan and Hong Kong were not material to the Company's business, operating results or financial condition. - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Readers are cautioned that other sections and other sentences not so identified may also contain forward-looking information. 27 29 The Company is in the process of addressing the issues raised by the introduction of the Single European Currency ("Euro") as of January 1, 1999 and during the transition period through January 1, 2002. The Company expects that its internal systems that will be affected by the initial introduction of the Euro will be Euro-capable by January 1, 1999 and does not expect the costs of system modifications to be material. The Company does not presently expect that introduction and use of the Euro will materially affect the Company's foreign exchange activities, or the Company's use of derivative instruments, or will result in any material increase in costs to the Company.* While the Company will continue to evaluate the impact of the Euro introduction over time, based on currently available information, management does not believe that the introduction of the Euro currency will have a material adverse impact on the Company's financial condition or overall trends in results of operations.* - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Readers are cautioned that other sections and other sentences not so identified may also contain forward-looking information. 28 30 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS DESCRIPTION PAGE ----------- ---- Report of Ernst & Young LLP, Independent Auditors........... 30 Consolidated Balance Sheets as of July 3, 1998 and June 27, 1997...................................................... 31 Consolidated Statements of Operations for the Years Ended July 3, 1998, June 27, 1997 and June 28, 1996............. 32 Consolidated Statements of Cash Flows for the Years Ended July 3, 1998, June 27, 1997 and June 28, 1996............. 33 Consolidated Statements of Stockholders' Equity for the Years Ended July 3, 1998, June 27, 1997 and June 28, 1996...................................................... 34 Notes to the Consolidated Financial Statements.............. 35 - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Readers are cautioned that other sections and other sentences not so identified may also contain forward-looking information. 29 31 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Stockholders Seagate Software, Inc. We have audited the accompanying consolidated balance sheets of Seagate Software, Inc. as of July 3, 1998 and June 27, 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended July 3, 1998. Our audits also included the financial statement schedule listed in the Index at Item 14(a)(2). These consolidated financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Seagate Software, Inc. at July 3, 1998 and June 27, 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended July 3, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. As discussed more fully in the Summary of Significant Accounting Policies footnote, Seagate Software, Inc. has modified the methods used to assess impairment of goodwill and, accordingly, has restated the consolidated financial statements for the fiscal years ended July 3, 1998 and June 27, 1997 to reflect this change. /s/ Ernst & Young LLP San Jose, California July 17, 1998, except for the second paragraph of the Summary of Significant Accounting Policies footnote, as to which the date is April 8, 1999 30 32 SEAGATE SOFTWARE, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) ASSETS JULY 3, JUNE 27, 1998 1997 -------- -------- Cash........................................................ $ 15,130 $ 12,085 Accounts receivable, net.................................... 46,564 28,172 Inventories................................................. 1,117 3,206 Other current assets........................................ 2,474 4,040 -------- -------- Total current assets.............................. 65,285 47,503 Property, equipment and leasehold improvements, net......... 16,876 20,785 Goodwill and other intangibles, net......................... 56,836 79,043 -------- -------- Total assets...................................... $138,997 $147,331 ======== ======== LIABILITIES Loan payable to Seagate Technology.......................... $ 16,054 $ 28,971 Accounts payable............................................ 10,994 9,116 Accrued employee compensation............................... 14,365 10,267 Accrued expenses............................................ 15,339 16,035 Accrued income taxes........................................ 5,562 2,699 Deferred revenue............................................ 13,714 8,354 -------- -------- Total current liabilities......................... 76,028 75,442 Deferred income taxes....................................... 1,691 6,233 Other liabilities........................................... 255 301 -------- -------- Total liabilities................................. 77,974 81,976 Common stock subject to repurchase.......................... 3,917 -- STOCKHOLDERS' EQUITY Convertible preferred stock, $.001 par value-- 73,000,000 shares authorized; Series A: shares issued and outstanding -- 54,633,333 in 1998 and 1997 (aggregate liquidation preference of $409,750 in 1998 and 1997)...... 55 55 Common stock, $.001 par value -- 95,600,000 shares authorized; shares issued and outstanding -- 235,502 in 1998 and 83,355 in 1997................................... -- -- Additional paid-in capital.................................. 343,526 342,091 Accumulated deficit......................................... (286,218) (276,948) Foreign currency translation adjustment..................... (257) 157 -------- -------- Total stockholders' equity........................ 57,106 65,355 -------- -------- Total liabilities and stockholders' equity........ $138,997 $147,331 ======== ======== See notes to consolidated financial statements. 31 33 SEAGATE SOFTWARE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) FOR THE YEARS ENDED ------------------------------------- JULY 3, JUNE 27, JUNE 28, 1998 1997 1996 -------- ------------ --------- Revenues: Licensing............................................ $243,285 $ 183,556 $ 124,380 Licensing from Seagate Technology.................... 5,469 5,762 9,374 Maintenance, support and other....................... 44,472 27,632 7,832 -------- ------------ --------- Total revenues.................................... 293,226 216,950 141,586 Cost of revenues: Licensing............................................ 16,963 17,535 14,885 Licensing from Seagate Technology.................... 539 1,834 3,999 Maintenance, support and other....................... 19,687 6,560 194 Amortization of developed technologies............... 13,271 21,860 9,941 -------- ------------ --------- Total cost of revenues............................ 50,460 47,789 29,019 -------- ------------ --------- Gross profit........................................... 242,766 169,161 112,567 Operating expenses: Sales and marketing.................................. 129,343 107,706 71,129 Research and development............................. 47,173 42,842 36,897 General and administrative........................... 37,124 36,861 22,852 In-process research and development.................. 6,800 2,613 96,958 Amortization of goodwill and other intangibles....... 16,201 23,465 13,035 Restructuring costs.................................. -- 2,524 9,502 Unusual items........................................ -- 13,446 -- -------- ------------ --------- Total operating expenses.......................... 236,641 229,457 250,373 -------- ------------ --------- Income (loss) from operations.......................... 6,125 (60,296) (137,806) Interest expense....................................... (1,021) (2,688) (970) Other, net............................................. 1,011 307 360 -------- ------------ --------- Interest and other, net.............................. (10) (2,381) (610) -------- ------------ --------- Income (loss) before income taxes...................... 6,115 (62,677) (13,416) Benefit from (provision for) income taxes.............. (15,385) 8,714 8,748 -------- ------------ --------- Net loss............................................... $ (9,270) $ (53,963) $(129,668) ======== ============ ========= Net loss per common share: Basic................................................ $ (56.33) $ (796.93) Diluted.............................................. $ (56.33) $ (796.93) Number of shares used in per share computations: Basic................................................ 164,571 67,714 Diluted.............................................. 164,571 67,714 See notes to consolidated financial statements. 32 34 SEAGATE SOFTWARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) FOR THE YEARS ENDED -------------------------------- JULY 3, JUNE 27, JUNE 28, 1998 1997 1996 --------- -------- --------- OPERATING ACTIVITIES Net loss.................................................... $ (9,270) $(53,963) $(129,668) Adjustments to reconcile net income to net cash from operating activities: Depreciation and amortization............................. 39,932 41,730 24,737 Deferred income taxes..................................... (4,542) (7,505) (3,021) Write-off of in-process research and development.......... 6,800 2,613 96,958 Write-off or write-down of goodwill and intangibles....... 1,900 13,106 2,157 Unusual items............................................. -- 13,446 -- Write-offs due to restructure............................. -- 1,494 4,427 Changes in operating assets and liabilities: Accounts receivable.................................... (18,157) 4,583 (12,129) Inventories............................................ 2,099 (1,581) (11) Other current assets................................... 1,575 (1,207) 1,080 Accounts payable....................................... 1,552 (1,609) 4,887 Accrued employee compensation.......................... 4,020 2,078 2,570 Accrued expenses....................................... (725) 2,430 4,629 Accrued income taxes................................... 3,633 5,796 (3,297) Deferred revenue....................................... 5,285 2,648 1,613 Other liabilities...................................... (46) 44 (3,267) --------- -------- --------- Net cash provided by (used in) operating activities....... 34,056 24,103 (8,335) INVESTING ACTIVITIES Acquisitions of businesses, net of cash acquired............ (10,000) -- (94,007) Acquisition of property, equipment and leasehold improvements, net......................................... (7,992) (15,823) (10,167) Escrow establishment........................................ -- -- (18,000) Decrease in other non-current assets, net................... -- -- 1,560 Acquisition of intangibles.................................. (4,270) -- -- --------- -------- --------- Net cash (used in) investing activities................... (22,262) (15,823) (120,614) FINANCING ACTIVITIES Sale of common stock........................................ 665 79 -- Sale of common stock subject to repurchase.................. 3,917 -- -- Funding by Seagate Technology for acquisitions of businesses................................................ -- -- 108,400 Borrowings from Seagate Technology.......................... 261,917 217,513 150,117 Payment to Seagate Technology............................... (274,834) (221,533) (129,699) --------- -------- --------- Net cash provided by (used in) financing activities....... (8,335) (3,941) 128,818 Effect of exchange rate changes on cash..................... (414) 151 8 --------- -------- --------- Increase (decrease) in cash............................... 3,045 4,490 (123) Elimination of Arcada's net cash activity for the duplicated six months ended December 31, 1995.......... -- -- 1,768 Cash at the beginning of the year........................... 12,085 7,595 5,950 --------- -------- --------- Cash at the end of the year................................. $ 15,130 $ 12,085 $ 7,595 ========= ======== ========= SUPPLEMENTAL CASH FLOW INFORMATION Cash paid for interest.................................... $ 50 $ 214 $ 36 Cash paid for income taxes................................ 7,945 2,357 4,892 See notes to consolidated financial statements. 33 35 SEAGATE SOFTWARE, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY SERIES A FOR THE YEARS ENDED CONVERTIBLE COMMON FOREIGN JULY 3, 1998, JUNE 27, 1997 PREFERRED STOCK STOCK ADDITIONAL CURRENCY AND JUNE 28, 1996 ------------------- ---------------- PAID-IN TRANSLATION ACCUMULATED (IN THOUSANDS, EXCEPT SHARE DATA) SHARES AMOUNT SHARES AMOUNT CAPITAL ADJUSTMENT DEFICIT TOTAL --------------------------------- ---------- ------ ------- ------ ---------- ----------- ----------- --------- BALANCE AT JUNE 30, 1995............ -- $-- -- $-- $140,610 $ 2 $ (93,397) $ 47,215 Acquisition by Seagate Technology of OnDemand Software, Inc. and minority interest of Arcada Holdings, Inc..................... -- -- -- -- 98,249 -- -- 98,249 Issuance of convertible preferred stock and common stock to Seagate Technology pursuant to the formation of Seagate Software..... 34,500,000 34 62,500 -- (34) -- -- -- Issuance of convertible preferred stock to Seagate Technology pursuant to the acquisition of Calypso Software Systems, Inc..... 1,733,333 2 -- -- 13,797 -- -- 13,799 Issuance of convertible preferred stock to Seagate Technology pursuant to the acquisition of Holistic Systems, Ltd............. 11,200,000 11 -- -- 84,046 -- -- 84,057 Income tax benefit from Seagate Technology stock option exercises......................... -- -- -- -- 1,866 -- -- 1,866 Foreign currency translation adjustment........................ -- -- -- -- -- 4 -- 4 Net loss............................ -- -- -- -- -- -- (129,668) (129,668) Elimination of Arcada Holdings, Inc. activity for the duplicated six months ended December 31, 1995.... -- -- -- -- -- -- 80 80 ---------- --- ------- --- -------- ----- --------- --------- BALANCE AT JUNE 28, 1996............ 47,433,333 47 62,500 -- 338,534 6 (222,985) 115,602 Income tax benefit from Seagate Technology stock option exercises......................... -- -- -- -- 3,486 -- -- 3,486 Issuance of common stock upon exercise of employee stock options........................... -- -- 20,855 -- 79 -- -- 79 Issuance of convertible preferred stock pursuant to the transfer to the Company of IMG Vancouver...... 7,200,000 8 -- -- (8) -- -- -- Foreign currency translation adjustment........................ -- -- -- -- -- 151 -- 151 Net loss............................ -- -- -- -- -- -- (53,963) (53,963) ---------- --- ------- --- -------- ----- --------- --------- BALANCE AT JUNE 27, 1997............ 54,633,333 55 83,355 -- 342,091 157 (276,948) 65,355 Income tax benefit from Seagate Technology stock option exercises......................... -- -- -- -- 770 -- -- 770 Issuance of common stock upon exercise of employee stock options........................... -- -- 152,147 -- 665 -- -- 665 Foreign currency translation adjustment........................ -- -- -- -- -- (414) -- (414) Net loss............................ -- -- -- -- -- -- (9,270) (9,270) ---------- --- ------- --- -------- ----- --------- --------- BALANCE AT JULY 3, 1998............. 54,633,333 $55 235,502 $-- $343,526 $(257) $(286,218) $ 57,106 ========== === ======= === ======== ===== ========= ========= See notes to consolidated financial statements. 34 36 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS. Seagate Software, Inc. ("Seagate Software") develops and markets software products and provides related services enabling business users and information technology professionals to manage enterprise information. Headquartered in Scotts Valley, California, Seagate Software has over 40 offices and operations in 17 countries worldwide. Seagate Software is a majority-owned and consolidated subsidiary of Seagate Technology, Inc. (the "Parent Company" or "Seagate Technology"), a data technology company that provides products for storing, managing and accessing digital information on computer systems. As of July 3, 1998, Seagate Technology and one of its subsidiaries held 99.7% of Seagate Software's outstanding capital stock. On a diluted basis, the outstanding minority interests of Seagate Software amounted to approximately 17.8%, which consisted of Common Stock and options to purchase Common Stock issued pursuant to the Option Plan. Such options to purchase Seagate Software's Common Stock are held by certain employees, directors and consultants of Seagate Software and Seagate Technology. RESTATEMENT OF FINANCIAL STATEMENTS. Seagate Software had previously allocated a portion of goodwill to developed technology and evaluated the impairment of goodwill based on the revenues from the related software. Using this method, Seagate Software recorded write-downs and write-offs of goodwill in fiscal 1997 in the amount of $10,259,000. Seagate Software has re-evaluated its methodology and determined that goodwill should not be allocated to developed technology under Accounting Principles Board Opinion 17, "Intangible Assets". As a result, Seagate Software has made adjustments to decrease the amounts of goodwill previously written-down and written-off from $10,259,000 to $6,173,000 in fiscal 1997. The additional goodwill of $4,086,000 is being amortized over the remaining estimated useful lives of approximately 5 years. The effect of this adjustment on previously reported consolidated financial statements as of and for the years ended July 3, 1998 and June 27, 1997 is as follows (in thousands except per share amounts): AS REPORTED AS RESTATED ---------------------------- ---------------------------- JULY 3, 1998 JUNE 27, 1997 JULY 3, 1998 JUNE 27, 1997 ------------ ------------- ------------ ------------- Amortization of goodwill..................... $ 15,421 $ 27,202 $ 16,201 $ 23,465 Income(loss) from operations................. 6,905 (64,033) 6,125 (60,296) Net (loss)................................... (8,490) (57,700) (9,270) (53,963) Basic and diluted (loss) per share........... (51.59) (852.11) (56.33) (796.93) Goodwill and other intangible assets, net.... 53,879 75,306 56,836 79,043 Accumulated deficit.......................... (289,175) (280,685) (286,218) (276,948) BASIS OF PRESENTATION. These financial statements are presented as if Seagate Software had existed as an entity separate from Seagate Technology during the periods presented and include the historical assets, liabilities, revenues and expenses that are directly related to Seagate Software's operations. Intercompany transactions and balances have been eliminated. Seagate Software was incorporated in Delaware in November 1993 and commenced operations in May 1994 pursuant to Seagate Technology's merger with Crystal Computer Services, Inc., a company engaged in developing and marketing report writing software. From August 1994 to June 1996, Seagate Technology acquired eight software companies, which were engaged in developing and marketing business intelligence or network and/or storage management software products. The amount of capital contributed by Seagate Technology for acquisitions was determined by the amounts paid for such acquisitions by Seagate Technology on behalf of Seagate Software. In February 1996, Seagate Technology merged with Conner Peripherals, Inc. in a transaction accounted for as a pooling-of-interests. In connection with the merger, Seagate Technology purchased the outstanding minority interests in Conner's storage management software operations under Arcada Holdings, Inc. In April 1996, Seagate Technology consolidated its software operations into Seagate Software. Prior to December 1996, Seagate Technology International, a wholly-owned subsidiary of Seagate Technology, owned all outstanding capital stock of Information Management Group Vancouver (formerly Crystal Services, Inc.). Pursuant to an agreement among Seagate Technology, Seagate Software and Information Management Group Vancouver dated December 19, 1996, Seagate Technology surrendered the 35 37 Information Management Group Stock (which was subsequently cancelled by Information Management Group Vancouver) in exchange for 7,200,000 Convertible Preference Shares of Information Management Group Vancouver. On December 26, 1996, the Convertible Preference Shares were exchanged for 7,200,000 Class B Exchangeable Shares of Information Management Group Vancouver. These Class B Exchangeable Shares do not have voting rights except as required by law, but can be exchanged at Seagate Technology's sole discretion for 7,200,000 shares of Seagate Software Series A Preferred Stock. In connection with the issuance of the Class B Exchangeable Shares described above, Seagate Technology was granted voting rights in Seagate Software equivalent to 7,200,000 shares of Series A Preferred Stock. Also on December 26, 1996, Information Management Group Vancouver issued 10,000 Class A Common Shares, which carry the right to vote, to Seagate Software. Seagate Software therefore now owns all voting shares of Information Management Group Vancouver. For financial reporting purposes, Seagate Software has control over Information Management Group Vancouver and therefore consolidates the results of Information Management Group Vancouver. Additionally, the 7,200,000 shares of Series A Preferred Stock of Seagate Software which Seagate Technology could elect to receive in exchange for the Class B Exchangeable Shares of Information Management Group Vancouver have been treated as issued and outstanding shares of Series A Preferred Stock of Seagate Software. In June 1998, Seagate Software Company acquired all of the outstanding capital stock of Eastman Software Storage Management Group, Inc., a company engaged in developing, producing and marketing hierarchical storage management products for the Windows NT platform. The purchase price of approximately $10,000,000 was paid in cash. Approximately $6,800,000 of the total purchase price represented the value of in-process technology that had not yet reached technological feasibility, had no alternative future use and was charged to Seagate Software's operations in the quarter ended July 3, 1998. The Company accounted for the acquisition using the purchase method, and the results of operations of Eastman are only included in Seagate Software's operations since the acquisition was completed. Pro forma financial information is not presented as such amounts are not material. Seagate Software operates and reports financial results on a fiscal year of 52 or 53 weeks ending on the Friday closest to June 30. Accordingly, fiscal 1998 ended on July 3, 1998, fiscal 1997 ended on June 27, 1997 and fiscal 1996 ended on June 28, 1996. Fiscal 1998 was comprised of 53 weeks and fiscals 1997 and 1996 were comprised of 52 weeks. Fiscal 1999 will be a 52-week year and will end on July 2, 1999. All references to years in the notes to consolidated financial statements represent fiscal years unless otherwise noted. Arcada, which was acquired by Seagate Software pursuant to Seagate Technology's merger with Conner, had a fiscal year that ended on the Saturday closest to December 31. Accordingly, Arcada's statement of operations for the year ended December 30, 1995 has been combined with Seagate Software's statement of operations for the year ended June 30, 1995. In order to conform Arcada's fiscal year end to Seagate Software's fiscal year end, Seagate Software's consolidated statement of operations for the year ended June 28, 1996 includes six months (July 1, 1995 through December 31, 1995) for Arcada which are also included in Seagate software's consolidated statement of operations for the year ended June 30, 1995. ECONOMIC DEPENDENCE ON SEAGATE TECHNOLOGY. Seagate Software has incurred net losses since inception and had net losses aggregating $192,901,000 during the three year period ended July 3, 1998 and had a working capital deficit at July 3, 1998 of $10,743,000. On July 4, 1998 Seagate Software and Seagate Technology renewed the Revolving Loan Agreement on substantially the same terms and conditions as the prior agreement which was dated June 28, 1996. Under the Revolving Loan Agreement, Seagate Technology finances certain of Seagate Software's working capital needs. The Revolving Loan Agreement provides for maximum outstanding borrowings of up to $60,000,000 and is renewable every two years. Outstanding borrowings from the Parent Company were $16,054,000 and $28,971,000 at July 3, 1998 and June 27, 1997, respectively. Borrowings from Seagate Technology consist primarily of amounts used to fund Seagate Software's operating activities. Beginning in fiscal 1999, Seagate Software will pay interest at the LIBOR rate plus 2% per annum on such borrowings; Seagate Software previously paid interest at 6%. Seagate Software is economically dependent on Seagate Technology and believes that to the extent future cash flows from operations and borrowings under the existing loan agreement with Seagate Technology are not sufficient to 36 38 fund Seagate Software's working capital deficit and planned activities during the next 12 months, that additional funding will be available at a reasonable cost from Seagate Technology. ACCOUNTING ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates. CONCENTRATION OF CREDIT RISK. Financial instruments that potentially subject Seagate Software to significant concentrations of credit risk consist primarily of cash and accounts receivable. Seagate Software places its cash and cash equivalents in high credit quality financial institutions. Accounts receivable are derived from revenues earned from customers primarily located in North America and Europe. Seagate Software performs ongoing credit evaluations of its customers and generally does not require collateral. Seagate Software maintains reserves for potential credit losses and historically such losses have been immaterial. Revenue from one third party customer, Ingram Micro Inc., accounted for 22%, 18% and 16% of Seagate Software's total revenues in 1998, 1997 and 1996, respectively. FOREIGN CURRENCY TRANSLATION. The U.S. dollar is the functional currency for most of Seagate Software's foreign operations. Gains and losses on the remeasurement into U.S. dollars of amounts denominated in foreign currencies are included in net income for those operations whose functional currency is the U.S. dollar. Gains and losses on translation into U.S. dollars of foreign operations whose functional currency is the local currency are recorded as a separate component of stockholders' equity. CASH MANAGEMENT. Seagate Technology uses a centralized cash management function for all of its domestic operations, including certain domestic operations of Seagate Software. A substantial majority of Seagate Software's cash is from balances maintained by Seagate Software's foreign subsidiaries. CASH AND CASH EQUIVALENTS. Seagate Software considers all highly liquid investments with an original maturity of 90 days or less at the time of purchase to be cash equivalents. Seagate Software typically uses available cash in excess of amounts required for operating activities to pay amounts due under the Revolving Loan Agreement. Accordingly, Seagate Software has not had significant cash equivalents to date. INVENTORIES. Inventories are stated at the lower of cost (first in, first out method) or market, and consist primarily of materials used in software products, related supplies and packaging materials. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS. Property and equipment, including leasehold improvements, are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets which range from two to five years. Assets under capital leases and leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful lives of the assets or the remaining lease term. GOODWILL AND OTHER INTANGIBLE ASSETS. Goodwill represents the excess of the purchase price of acquired companies over estimated fair values of tangible and intangible net assets acquired. Goodwill is amortized on a straight-line basis over five to seven years. The carrying values of long-term assets and intangibles other than developed technology ("other intangibles") are reviewed if facts and circumstances suggest that they may be impaired. If this review indicates that carrying values of long-term assets and other intangibles and associated goodwill will not be recoverable based on projected undiscounted future cash flows, carrying values are reduced to estimated fair values by first reducing goodwill and second by reducing long-term assets and other intangibles. Other intangible assets consist of trademarks, assembled workforces, distribution networks, developed technology, customer bases, and covenants not to compete related to acquisitions accounted for by the purchase method. See Note on Business Combinations and Acquisitions. Amortization of purchased intangibles, other than acquired developed technology, is provided on the straight-line basis over the respective useful lives of the assets ranging from 36 to 60 months for trademarks, 24 to 48 months for assembled workforces and distribution networks, 12 to 36 months for customer bases and 18 to 24 months for covenants 37 39 not to compete. In-process research and development without alternative future use is expensed when acquired. DEVELOPED TECHNOLOGY. Seagate Software applies Statement of Financial Accounting Standards No. 86 ("SFAS 86"), "Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed", to software technologies developed internally, acquired in business acquisitions, and purchased. Internal development costs are included in research and development and are expensed as incurred. SFAS 86 requires the capitalization of certain internal development costs once technological feasibility is established, which based on Seagate Software's development process generally occurs upon the completion of a working model. As the time period between the completion of a working model and the general availability of software has been short, capitalization of internal development costs has not been material to date. Capitalized costs are amortized based on the greater of the straight-line basis over the estimated product life (generally 30 to 48 months) or the ratio of current revenues to the total of current and anticipated future revenues. Purchased developed technology is amortized based on the greater of the straight-line basis over the estimated useful life (30 to 48 months) or the ratio of current revenues to the total of current and anticipated future revenues. The recoverability of the carrying value of purchased developed technology and associated goodwill is reviewed periodically. The carrying value of developed technology is compared to the estimated future gross revenues from that product reduced by the estimated future costs of completing and disposing of that product, including the costs of performing maintenance and customer support (net undiscounted cash flows ) and to the extent that the carrying value exceeds the undiscounted cash flows the difference is written off. FAIR VALUE DISCLOSURES. Seagate Software maintains its cash principally with major banks in interest-and non-interest-bearing bank accounts. There are no realized or unrealized gains or losses and fair value approximates carrying value for all cash balances. PUSHDOWN AND CARVEOUT ACCOUNTING. Seagate Technology has provided substantial services to Seagate Software, including general management, treasury, tax, financial reporting, benefits administration, insurance, information technology, legal, accounts payable and receivable and credit functions. Seagate Technology has charged Seagate Software for these services through corporate expense allocations. The amount of corporate expense allocations is dependent upon the total amount of allocable costs incurred by Seagate Technology on behalf of Seagate Software less amounts charged as a specific cost or expense rather than by allocation. Such costs were proportionately allocated to Seagate Software based on detailed inquiries and estimates of time incurred by Seagate Technology's corporate marketing and general and administrative departmental managers. Included in general and administrative expenses are corporate allocation charges of $1,004,000, $1,939,000 and $2,242,000 for 1998, 1997 and 1996, respectively. Included in sales and marketing expenses are corporate allocation charges of $769,000, $19,000 and $18,000 for 1998, 1997 and 1996, respectively. The increase in sales and marketing expenses in 1998 was due to proportional costs allocations from Seagate Technology's corporate branding program, which consisted of television and newspaper advertisements. Seagate Software participated in Seagate Technology's profit sharing plan through the first quarter of fiscal 1998 and in Seagate Technology's management bonus plan during 1997. Seagate Software has since adopted its own bonus plan. Compensation expenses recorded by Seagate Software under Seagate Technology's plans totaled $0, $3,158,000 and $910,000 for 1998, 1997 and 1996, respectively. The employees of Seagate Software also participate in the Seagate Technology Employee Stock Purchase Plan (the "Purchase Plan"). The Purchase Plan permits eligible employees who have completed thirty days of employment prior to the inception of the offering period to purchase common stock of Seagate Technology through payroll deductions at the lower of 85% of the fair market value of the common stock at the beginning or at the end of each six-month offering period. Under the plan, 115,058, 80,643 and 41,574 shares of common stock of Seagate Technology were issued to Seagate Software's employees in 1998, 1997 and 1996, respectively. 38 40 The employees of Seagate Software also participate in the Seagate Technology tax-deferred savings plan, the Seagate Technology, Inc. Savings and Investment Plan ("the 401(k) plan"). The 401(k) plan is designed to provide qualified employees with an accumulation of funds at retirement. Qualified employees may elect to make contributions to the 401(k) plan on a monthly basis. Seagate Software may make annual contributions to the 401(k) plan at the discretion of the Board of Directors. No material contributions were made by Seagate Software in fiscal years 1998, 1997 or 1996. REVENUE RECOGNITION. Seagate Software recognizes revenue in accordance with the American Institute of Certified Public Accountants Statement of Position 91-1, "Software Revenue Recognition". Seagate Software's total revenues are derived from license revenues for its various software products as well as maintenance, support, training and consulting. Revenues for maintenance, support services, training and consulting are recognized separately from software licenses. License revenues are recognized upon delivery of the product if no significant vendor obligations remain and collection of the resulting receivable is probable. Allowances for estimated future returns are provided upon shipment. Maintenance and support revenues consist of ongoing support and product updates and are recognized ratably over the term of the contract, which is typically twelve months. Revenues from training and consulting are recognized when the services are performed. Revenues from resellers, including VARs, OEMs, distributors and Seagate Technology, are primarily recognized at the time of product delivery to the reseller. Seagate Software's policy to defer such revenues if resale contingencies exists. Some of the factors that are considered to determine the existence of such contingencies include payment terms, collectibility and past history with the customer. Product returns are reserved for in accordance with SFAS 48. Such returns are estimated based on historical return rates. Seagate Software considers other factors such as fixed and determinable fees, resale contingencies, arms length contract terms and the ability to reasonably estimate returns to ensure compliance with SFAS 48. Additionally, Seagate Software continually reviews its estimated product return provisions to ensure that they are reasonable in relation to actual product returns, which are quantified based on approved return authorization forms received prior to fiscal cutoff dates. Historically, Seagate Software's estimated product return rates have not varied materially from actual product return rates. In October 1997 and March 1998, the American Institute of Certified Public Accountants issued Statements of Position 97-2, "Software Revenue Recognition" ("SOP 97-2") and 98-4, "Deferral of the Effective Date of a Provision of SOP 97-2, Software Revenue Recognition" ("SOP 98-4"), which Seagate Software currently is required to adopt for transactions entered into after July 3, 1998. SOP 97-2 and SOP 98-4 provide guidance on recognizing revenue on software transactions and supersede SOP 91-1. Seagate Software has assessed the impact of the requirements of SOP 97-2 and SOP 98-4 and has changed certain of its policies and procedures. Seagate Software believes that the adoption of SOP 97-2 and SOP 98-4 will not have a significant impact on Seagate Software's revenues or results of operations. ADVERTISING EXPENSE. The cost of advertising is expensed as incurred. Seagate Software does not incur any direct response advertising costs. Advertising costs totaled $19,112,000, $21,617,000 and $15,748,000 for 1998, 1997 and 1996, respectively. NET LOSS PER SHARE. The net loss per common share is computed using the weighted average number of shares of common stock outstanding during the period. Common equivalent shares from common stock options and convertible preferred stock are excluded from the computation of diluted net loss per share, as their effect is antidilutive. The net loss per common share for 1996 is not presented because Seagate Software's current capital structure did not exist prior to April 1996, making presentation for prior periods not meaningful. During 1998, Seagate Software adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). The adoption of SFAS 128 and the required restatement of the 1997 net loss per share had no impact on Seagate Software because the weighted average shares used in the per share computations were unchanged under SFAS 128 because the effect of stock options would have been 39 41 antidilutive. Below is a reconciliation of the numerator and denominator used to calculate earnings per share (in thousands, except share and per share data): FOR THE YEAR ENDED JULY 3, JUNE 27, 1998 1997 ------- -------- Net loss per share computation -- basic and diluted: Numerator: Net loss................................... $(9,270) $(53,963) ------- -------- Denominator: Weighted average number of common shares outstanding during the period.................... 164,571 67,714 ------- -------- Net loss per share -- basic and diluted.......... $(56.33) $(796.93) ======= ======== Incremental common shares attributable to the exercise of outstanding options and common stock subject to repurchase (assuming the proceeds would be used to purchase treasury stock) aggregating 2,118,034 shares for the year ended July 3, 1998 and 317,453 shares for 1997 were not included in the diluted net loss per share computations because the effect would have been antidilutive. ACCOUNTS RECEIVABLE. Accounts receivable are summarized below, in thousands: 1998 1997 ------- ------- Accounts receivable...................................... $48,200 $29,442 Less allowance for non-collection........................ (1,636) (1,270) ------- ------- $46,564 $28,172 ======= ======= INVENTORY. The write-downs of inventory to the lower of cost or market were $3,674,000, $531,000 and $800,000 in 1998, 1997, and 1996 respectively. The write-down in fiscal 1998 was a result of consolidating Seagate Software's fulfillment warehouses and changing their strategy to have fulfillment activities handled by an outsourcing partner. As a result of this consolidation excess and obsolete components and finished goods were written down. The write-down in fiscal 1997 and 1996 related to excess and obsolete components and finished goods inventory. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS. Property, equipment and leasehold improvements consisted of the following, in thousands: ESTIMATED USEFUL LIFE 1998 1997 ----------------- ------- ------- Equipment..................................... Two to five years $30,999 $30,009 Building and leasehold improvements........... Life of lease 9,424 6,428 ------- ------- 40,423 36,437 Less accumulated depreciation and amortization................................ (23,547) (15,652) ------- ------- $16,876 $20,785 ======= ======= Depreciation expense was $11,727,000, $8,911,000 and $3,918,000 in 1998, 1997 and 1996, respectively. 40 42 GOODWILL AND OTHER INTANGIBLES. Goodwill and other intangibles consisted of the following, in thousands: 1998 1997 ------- ------- Goodwill................................................. $49,039 $50,286 Developed technology..................................... 48,049 46,136 Trademarks............................................... 9,972 9,972 Assembled workforce...................................... 4,596 6,666 Distribution network..................................... 2,925 2,925 Other intangibles........................................ 13,813 12,853 ------- ------- 128,394 128,838 Accumulated amortization................................. (71,558) (49,795) ------- ------- Goodwill and other intangibles........................... $56,836 $79,043 ======= ======= Amortization of developed technologies is included in costs of revenues. In 1998, 1997 and 1996 the amortization of goodwill and other intangibles includes write-offs and write-downs to the estimated fair value of $1,900,000, $6,173,000 and $2,157,000, respectively. In 1997 the amortization of acquired developed technologies included in cost of revenues includes write-downs and write-offs to net realizable value of $6,918,000. Periodically, Seagate Software reviews the carrying value of its intangibles other than developed technology to ascertain if there has been any impairment. In 1996 the former owner of Frye computer Systems, Inc. (a 1995 acquisition), Mr. Frye, left Seagate Software. With his departure, Seagate Software decided to release Mr. Frye from the remaining period of his covenant not to compete and to not use the Frye name trademark in future products. As a result, the remaining carrying value of the covenant not to compete and trademark and associated goodwill totaling $1,932,000 were written off. Seagate Software also periodically reviews the net realizable value of developed technology under the guidance of SFAS No. 86. Seagate Software compares the estimated undiscounted future cash flows on a product by product basis to the unamortized cost of developed technology and unamortized costs in excess of the estimated undiscounted cash flows are written off. The impairment write-offs for developed technology recorded in 1997 were caused by a number of factors including Seagate Software's decision to stop selling products or technologies such as DOS, new acquisitions, or new product designs. Seagate Software is not currently generating revenue from any products for which the related developed technology has been impaired. In addition, Seagate Software assesses the impairment of goodwill not included in the scope of SFAS 121 under Accounting Principles Board Opinion No. 17, "Intangible Assets", (APB17). During 1997, Seagate Software wrote-off and wrote-down goodwill amounting to $6,173,000. The write-offs and write-downs related to the decision to abandon and stop selling all current and future products acquired from Frye Computer Systems, Inc., the decision to abandon and stop selling virtually all current and future products acquired in the acquisition of Palindrome Corporation, and the decision to close down and sell Calypso Software Systems, Inc. Seagate Software has capitalized the assembled workforce in most of its acquisitions. When Seagate Software reviews the carrying value of its intangibles, if there remains less than 5% of the original workforce, the related intangible is deemed impaired. In 1998, Seagate Software wrote off the workforces for three previous acquisitions, Network Computing, Inc., Netlabs, Inc., and Creative Interaction Technologies, Inc., because less than 5% of the original workforces remained. 41 43 The following table provides quantitative information about the write-offs and write-downs of goodwill and other intangibles, in thousands: 1996 1997 1998 ---------------------- --------------------- ---------------------- DEVELOPED INTANGIBLES GOODWILL TECHNOLOGY GOODWILL INTANGIBLES GOODWILL ----------- -------- ---------- -------- ----------- -------- Covenant not to compete Frye Computer Systems, Inc.......... $1,188 $744 Trademark Frye Computer Systems, Inc.......... $ 225 Developed Technology Netlabs, Inc........................ $ 780 Palindrome Corporation.............. 2,740 $2,930 Calypso Software Systems, Inc....... 1,627 2,573 Creative Interaction Technologies, Inc.............................. 1,176 Frye Computer Systems, Inc.......... 463 670 Network Computing, Inc.............. 132 Assembled Workforce Network Computing, Inc.............. $120 $ 155 Netlabs, Inc........................ 431 1,045 Creative Interaction Technologies, Inc.............................. 82 67 ------ ---- ------ ------ ---- ------ Total....................... $1,413 $744 $6,918 $6,173 $633 $1,267 ====== ==== ====== ====== ==== ====== COMMON STOCK SUBJECT TO REPURCHASE. Current employees and directors of Seagate Software and of Seagate Technology have exercised 740,065 shares of common stock under the Option Plan. At July 3, 1998, 176,455 shares were vested and 563,610 shares were unvested. At the option of the employee or director, within 30 days of termination such vested and unvested shares may be sold back to Seagate Software at the original issue price. In addition, upon termination, unvested shares are subject to repurchase at the option of Seagate Software at original issue price. Because of the obligation to repurchase vested and unvested shares of common stock, Seagate Software has excluded the amounts associated with the repurchase obligation from Stockholders' Equity in the accompanying balance sheet. At July 3, 1998, the repurchase obligation amounted to $3,917,000. NEW ACCOUNTING PRONOUNCEMENTS In October 1997 and March 1998, the American Institute of Certified Public Accountants issued Statements of Position 97-2, "Software Revenue Recognition" ("SOP 97-2") and 98-4, "Deferral of the Effective Date of a Provision of SOP 97-2, Software Revenue Recognition" ("SOP 98-4"), which Seagate Software currently is required to adopt for transactions entered into after July 3, 1998. SOP 97-2 and SOP 98-4 provide guidance on recognizing revenue on software transactions and supersede SOP 91-1. Seagate Software has assessed the impact of the requirements of SOP 97-2 and SOP 98-4 and has changed certain of its policies and procedures. Seagate Software believes that the adoption of SOP 97-2 and SOP 98-4 will not have a significant impact on Seagate Software's revenues or results of operations. Seagate Software intends to adopt Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"), and No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131") during fiscal 1999. Both standards will require additional disclosure, but will not have a material effect on Seagate Software's financial position or results of operations. SFAS 130 establishes standards for the reporting and display of comprehensive income and is expected to first be reflected in Seagate Software's first quarter of 1999 interim financial statements. The components of comprehensive income include net income and items that are currently reported directly as a component of stockholders' equity such as changes in foreign currency translation adjustments and changes in the fair value of available-for-sale financial instruments. SFAS 131 changes the way companies report segment information 42 44 and requires segments to be determined based on how management measures performance and makes decisions about allocating resources. SFAS 131 will first be reflected in Seagate Software's 1999 Annual Report on Form 10-K. In April 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 provides guidance on capitalization of the costs incurred for computer software developed or obtained for internal use. It also provides guidance for determining whether computer software is internal-use software and on accounting for the proceeds of computer software originally developed or obtained for internal use and then subsequently sold to the public. Seagate Software has not yet determined the impact, if any, of adopting this statement. The disclosures prescribed by SOP 98-1 will be effective for Seagate Software's consolidated financial statements for the fiscal year ending June 30, 2000. BUSINESS COMBINATIONS AND ACQUISITIONS Seagate Software acquired Eastman Software Storage Management Group, Inc. in 1998 and Arcada Holdings, Inc., Holistic Systems, Ltd., Calypso Software Systems, Inc., OnDemand Software, Inc. and Sytron Corporation in 1996. There were no acquisitions in 1997. Management is primarily responsible for estimating the fair values of tangible and intangible assets and liabilities acquired. In accordance with the provisions of APB Opinion 16, all identifiable assets, including identifiable intangible assets, were assigned a portion of the cost of the acquired enterprise (purchase price) on the basis of their respective fair values. This included the portion of the purchase price properly attributed to incomplete research and development projects that should be expenses according to the requirements of Interpretation 4 of SFAS No. 2. VALUATION OF ACQUIRED INTANGIBLE ASSETS. To determine the value of in-process research and development, Seagate Software considered, among other factors, the stage of development of each project, the time and cost needed to complete each project, expected income, associated risks which included the inherent difficulties and uncertainties in completing each project and thereby achieving technological feasibility and risks related to the viability of and potential changes to future target markets. This analysis resulted in amounts assigned to in-process research and development for projects that had not yet reached technological feasibility and which did not have alternative future uses. The Income Approach, which includes analysis of markets, cash flows, and risks associated with achieving such cash flows, was the primary technique utilized in valuing each in-process research and development project. The underlying in-process projects acquired were the most significant and uncertain assumptions utilized in the valuation analysis of in-process research and development projects. To determine the value of developed technologies, the expected future cash flows of existing product technologies were evaluated, taking into account risks related to the characteristics and applications of each product, existing and future markets and assessments of the life cycle stage of each product. Based on this analysis, the existing technologies that had reached technological feasibility were capitalized. To determine the value of the distribution networks and customer bases, Seagate Software considered, among other factors, the size of the current and potential future customer bases, the quality of existing relationships with customers, the historical costs to develop customer relationships, the expected income and associated risks. Associated risks included the inherent difficulties and uncertainties in transitioning the business relationships from the acquired entity to Seagate Software and risks related to the viability of and potential changes to future target markets. To determine the value of trademarks, Seagate Software considered, among other factors, the assumption that in lieu of ownership of a trademark, a company would be willing to pay a royalty in order to exploit the related benefits of such trademark. To determine the value of assembled workforces, Seagate Software considered, among other factors, the costs to replace existing employees including search costs, interview costs and training costs. 43 45 Goodwill is determined based on the residual difference between the amount paid and the values assigned to identified tangible and intangible assets. If the values assigned to identified tangible and intangible assets exceed the amounts paid, including the effect of deferred taxes, the values assigned to long-term assets were reduced proportionally until there was no negative goodwill. ACQUISITION OF EASTMAN SOFTWARE STORAGE MANAGEMENT GROUP, INC. In June 1998, Seagate Software acquired all of the outstanding capital stock of Eastman Software Storage Management Group, Inc. ("Eastman"), a company engaged in developing, producing and marketing hierarchical storage management products for the Windows NT platform. The purchase price of approximately $10,000,000 was paid in cash. Approximately $6,800,000 of the total purchase price represented the value of in-process technology that had not yet reached technological feasibility, had no alternative future uses and was charged to Seagate Software's operations in the quarter ended July 3, 1998. Seagate Software accounted for the acquisition using the purchase method, and the results of operations of Eastman are only included in Seagate Software's operations since the date the acquisition was completed. Pro forma financial information is not presented as such amounts are not material. The following is a summary of the purchase price allocation, in thousands: Current assets and other tangible assets................... $ 535 Liabilities assumed........................................ (508) Assembled workforce........................................ 340 Developed technology....................................... 500 In-process research and development........................ 6,800 Microsoft agreement........................................ 1,500 Goodwill................................................... 833 ------- $10,000 ======= Overview Eastman's two primary products are OPEN/stor for Windows NT and AvailHSM for NetWare. By integrating Eastman's product line, Seagate will be able to convert their Storage Migrator product into a stand-alone HSM application for Windows NT environments. As of the date of acquisition, the Company abandoned the AvailHSM product and technology due to dated features and functionality; the valuation analysis did not include a fair value for the AvailHSM product. As for OPEN/stor at the date of acquisition, the Company planned to phase out the product over the following 12 to 15 months. Seagate's purpose for the acquisition was for the next generation technologies that were underway at Eastman, referenced by project names Sakkara and Phoenix. These projects were complete re-writes of Eastman's prior generation technology that would allow the product to be sold stand-alone upon completion. In accordance with SFAS 86, paragraph 38 ("Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed"), "the cost of software purchased to be integrated with another product or process will be capitalized only if technological feasibility was established for the software component and if all research and development activities for the other components of the product or process were completed at the time of the purchase." Although Seagate purchased existing products from Eastman, the existing products did not operate on a stand-alone basis. Therefore, as mentioned above, all of the original underlying code and base technology for the next generation products were in the process of being completely re-written as date of valuation. Assumptions Revenue Future revenue estimates were generated for the following technologies: (i) OPEN/stor, (ii) Sakkara, and (iii) Phoenix. Aggregate revenue for existing Eastman products was estimated to be approximately $167,000 for the one month ending June 30, 1998. Revenues were estimated to increase to approximately 44 46 $3.9 million and $7.1 million for fiscal years 1999 and 2000 when most of the in-process projects were expected to be complete and shipping. Thereafter, revenue was estimated to increase at rates ranging from 20% to 30% for fiscal years 2001 through 2006. Revenue estimates were based on (i) aggregate revenue growth rates for the business as a whole, (ii) individual product revenues, (iii) growth rates for the storage management software market, (iv) the aggregate size of the storage management software market, (v) anticipated product development and introduction schedules, (vi) product sales cycles, and (vii) the estimated life of a product's underlying technology. Operating expenses Operating expenses used in the valuation analysis of Eastman included (i) cost of goods sold, (ii) general and administrative expense, (iii) selling and marketing expense, and (iv) research and development expense. In developing future expense estimates, an evaluation of both Seagate and Eastman's overall business model, specific product results, including both historical and expected direct expense levels (as appropriate), and an assessment of general industry metrics was conducted. Cost of goods sold. Cost of goods sold, expressed as a percentage of revenue, for the developed and in-process technologies was estimated to be approximately 5% throughout the estimation period. Seagate Software's cost of goods sold was 20% for fiscal 1996 and 22% for fiscal 1997. General and administrative ("G&A") expense. G&A expense, expressed as a percentage of revenue, for the developed and in-process technologies was estimated to be approximately 10% throughout the estimation period. Selling and marketing ("S&M") expense. S&M expense, expressed as a percentage of revenue, for the developed and in-process technologies was estimated to be 27% throughout the estimation period. Research and development ("R&D") expense. R&D expense consists of the costs associated with activities undertaken to correct errors or keep products updated with current information (also referred to as "maintenance" R&D). Maintenance R&D includes all activities undertaken after a product is available for general release to customers to correct errors or keep the product updated with current information. These activities include routine changes and additions. The maintenance R&D expense was estimated to be 5% of revenue for the developed and in-process technologies throughout the estimation period. In addition, as of the date of acquisition, Seagate Software's management anticipated the costs to complete the in-process technologies at approximately $1.8 million. Effective tax rate The effective tax rate utilized in the analysis of developed and in-process technologies was 38%, which reflects Seagate's combined federal and state statutory income tax rates, exclusive of non-recurring charges at the time of the acquisition and estimated for future years. Discount rate The discount rates selected for Eastman's developed and in-process technologies were 15% and 20%, respectively. In the selection of the appropriate discount rates, consideration was given to (i) the Weighted Average Cost of Capital (approximately 15% at the date of acquisition) and (ii) the Weighted Average Return on Assets (approximately 18%). The discount rate utilized for the in-process technology was determined to be higher than Seagate's WACC due to the fact that the technology had not yet reached technological feasibility as of the date of valuation. In utilizing a discount rate greater than Seagate's WACC, management has reflected the risk premium associated with achieving the forecasted cash flows associated with these projects. 45 47 ACQUISITION OF HOLISTIC SYSTEMS, LTD. In June 1996, Seagate Software acquired all of the outstanding shares of Holistic Systems, Ltd. a company engaged in developing, producing and marketing OLAP-compliant, integrated enterprise business intelligence systems encompassing facilities for executive information, decision support and other business intelligence applications. The purchase price of approximately $85,458,000 was paid in cash, and a portion of such consideration ($18,000,000) was placed in escrow for contingent consideration. The escrow was released by Seagate Software during the third quarter of fiscal 1997. Seagate Software accounted for the acquisition using the purchase method, and the results of operations of Holistic are only included in Seagate Software's operations since the date the acquisition was completed. The following is a summary of the initial purchase price allocation, in thousands: Current assets and other tangible assets................... $ 9,993 Liabilities assumed........................................ (5,087) Trademarks................................................. 5,889 Assembled workforce........................................ 1,890 Developed technology....................................... 16,453 Customer base.............................................. 3,746 In-process research and development........................ 35,892 Restricted cash held in escrow............................. 18,000 Deferred tax liability..................................... (1,318) Goodwill................................................... -- ------- $85,458 ======= The discount rates selected for Holistic's developed and in-process technologies were 15% and 17.5%, respectively. In the selection of the appropriate discount rates, consideration was given to (i) the Weighted Average Cost of Capital (approximately 15% at the date of the acquisition) and (ii) the Weighted Average Return on Assets (approximately 17%). The discount rate utilized for the in-process technology was determined to be higher than Seagate's WACC due to the fact that the technology has not yet reached technological feasibility as of the date of valuation. In utilizing a discount rate greater than Seagate's WACC, management has reflected the risk premium associated with achieving the forecasted cash flows associated with these projects. The underlying in-process project acquired was the most significant and uncertain assumption utilized in the valuation analysis of the in-process research and development. Management was primarily responsible for estimating the fair value of the purchased R&D in the Holistic acquisition. As noted above, $18,000,000 of the acquisition consideration was held in escrow as contingent consideration. Seagate Software decided to release to the former shareholders of Holistic the escrow funds of $18,000,000 in the third quarter of fiscal 1997 even though the required contingencies had not been satisfied. As a result, Seagate Software recorded compensation expense as an unusual item amounting to $13,446,000 for payments made to Company employees who were also former shareholders of Holistic and an additional purchase price amount of $4,554,000 for payments to former shareholders of Holistic who were not employees of Seagate Software. The additional purchase price was allocated based on the same methodology as the original purchase price and in the third quarter of 1997, Seagate Software recorded an additional in-process research and development write-off of $2,613,000, acquired intangible assets of $2,037,000 and a deferred tax liability of $96,000. As of the date of the acquisition, Holistic was in the process of developing the next generation of Holos, version 6.0, which was planned for release during the summer of 1997. Actual release of Holos, version 6.0, occurred in the fourth quarter of fiscal 1997. 46 48 ACQUISITION OF CALYPSO SOFTWARE SYSTEMS, INC. In May 1996, Seagate Software acquired all of the outstanding shares of Calypso Software Systems, Inc. ("Calypso"), a company engaged in developing, producing and marketing software for managing systems and applications in complex, distributed client/server computer networks. The purchase price of approximately $13,865,000 was paid in cash. Seagate Software accounted for the acquisition using the purchase method, and the results of operations of Calypso are only included in Seagate Software's operations since the date the acquisition was completed. The following is a summary of the purchase price allocation, in thousands: Current assets and other tangible assets................... $ 1,209 Liabilities assumed........................................ (245) Assembled workforce........................................ 400 Developed technology....................................... 3,600 Customer base.............................................. 540 In-process research and development........................ 5,400 Goodwill................................................... 2,961 ------- $13,865 ======= As of the date of acquisition, Calypso had undergone or was in the process of undergoing the re-write of code in C+, adding navigator capabilities, developing web server and browser interoperability, developing CORBA interoperability, and developing Network OLE/COM interoperability for Atrium EMS (stand-alone). The estimated cost to complete the in-process research and development projects acquired from Calypso was estimated to be approximately $750,000 as of the date of the acquisition. These in process research and development projects were successfully completed prior to a restructuring of operations in the third quarter of fiscal 1997. As a result of this restructuring and a change in Seagate Software's strategic direction, in the first quarter of fiscal 1998, Seagate Sofware disposed of all the developed and in process technologies originally acquired from Calypso. ACQUISITION OF ONDEMAND SOFTWARE, INC. In March 1996, Seagate Software acquired all of the outstanding shares and stock options of OnDemand Software, Inc. ("OnDemand"), a company engaged in developing, producing and marketing WinINSTALL, a product which automates installation, upgrades and uninstalls of network applications throughout the enterprise. The purchase price of approximately $13,425,000 was paid in cash. Seagate Software accounted for the acquisition using the purchase method, and the results of operations of OnDemand are only included in Seagate Software's operations since the date the acquisition was completed. The following is a summary of the purchase price allocation, in thousands: Current assets and other tangible assets................... $ 832 Liabilities assumed........................................ (227) Assembled workforce........................................ 270 Developed technology....................................... 2,000 Covenant not to compete.................................... 50 In-process research and development........................ 8,900 Goodwill................................................... 1,600 ------- $13,425 ======= ACQUISITION OF MINORITY INTEREST OF ARCADA HOLDINGS, INC. The combination of Seagate Software with Arcada Holdings, Inc. ("Arcada"), a company which developed, marketed and supported data protection and storage management software products that operated across multiple desktop and client/server environments, was accounted for as a pooling-of-interests and, accordingly, all prior periods presented in the accompanying 47 49 consolidated financial statements include the accounts and operations of Arcada. Arcada's results of operations for the duplicated six months ended December 30, 1995 were as follows, in thousands: FOR THE SIX MONTHS ENDED DECEMBER 30, 1995 ----------------- Net revenues......................................... $37,700 Operating expenses................................... 29,320 Other income......................................... 588 Net loss............................................. (80) In connection with the pooling-of-interests, Seagate Software acquired the then outstanding minority interest of Arcada. The minority interest was approximately 31% on a fully diluted basis. The acquisition of the minority interest was accounted for as a purchase and in connection with the acquisition, Seagate Technology issued 2,553,000 shares of common stock with a fair market value of approximately $52,009,000 and 1,817,000 options to purchase common stock with a fair market value of approximately $33,065,000 (aggregate fair value of $85,074,000). The value of the shares of Seagate Technology common stock issued to shareholders of Arcada was determined based on the average market price of Seagate Technology's common stock five days before and five days after October 3, 1995, the date that the terms of the acquisition were agreed to. The options were issued to employees of Arcada and Conner, Arcada's parent, in exchange for options of Arcada. The options have a term of 10 years and vest 1/16 per quarter over 4 years. The value of the options were based on the intrinsic value of options, which approximates the fair value The following is a summary of the purchase price allocation for the acquisition of the minority interest, in thousands: Assembled workforce........................................ $ 1,355 Distribution network....................................... 94 Corporate accounts......................................... 375 Strategic alliances........................................ 1,437 OEM agreements............................................. 3,217 Value added resellers...................................... 2,030 Trademarks................................................. 2,811 Developed technology....................................... 4,623 In-process research and development........................ 43,949 Deferred tax liability..................................... (6,254) Goodwill................................................... 31,437 ------- $85,074 ======= Intangible assets were identified through (i) analysis of the acquisition agreement, (ii) consideration of the Network & Storage Management Group's intentions for future use of the acquired assets, and (iii) analysis of data available concerning Arcada's products, technologies, markets, historical financial performance, estimates of future performance and the assumptions underlying those estimates. The economic and competitive environment in which the Network & Storage Management Group and Arcada operate was also considered in the valuation analysis. Specifically, purchased research and development ("purchased R&D") was identified and valued through extensive interviews and discussions with the Network & Storage Management Group and Arcada management and the analysis of data provided by Arcada concerning Arcada's developmental products, their respective stage of development, the time and resources needed to complete them, their expected income generating ability, target markets and associated risks. The Income Approach, which includes an analysis of the markets, cash flows, and risks associated with achieving such cash flows, was the primary technique utilized in valuing each purchased R&D project. A portion of the purchase price was allocated to the developmental projects based on the appraised fair values of such projects. 48 50 DISCUSSION OF IN-PROCESS RESEARCH & DEVELOPMENT ONE TIME WRITE-OFF Overview As of the acquisition date, Arcada had spent a significant amount of money on research and development related to the re-development efforts to add features and utilities to the Desktop, NetWare and Windows NT products such as disk grooming, hierarchical storage management, upgraded graphical user interfaces, file and server replication, and server mirroring in order to continue to meet increasingly complex user needs. In accordance with SFAS 86, paragraph 38 ("Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed"), "the cost of software purchased to be integrated with another product or process will be capitalized only if technological feasibility was established for the software component and if all research and development activities for the other components of the product or process were completed at the time of the purchase." Although Seagate purchased existing products from Arcada, since the majority of the original underlying code and base technology for the NetWare and Windows NT product families was completed in the 1990 time frame, the technologies, as of the date of valuation, were desperately in need of, and therefore, as mentioned above, was undergoing significant re-development. Assumptions Revenue Future revenue estimates were generated for the following product families: (i) Desktop, (ii) NetWare, and (iii) Windows NT. Aggregate revenue for Arcada products was estimated to be approximately $94 million for the ten and one-half months ending December 31, 1996. Revenues were estimated to increase to approximately $161 million and $233 million for calendar years 1997 and 1998 when most of the in-process projects were expected to be complete and shipping. Thereafter, revenue was estimated to increase at rates ranging from 35% to 40% for calendar years 1999 through 2002. Revenue estimates were based on (i) aggregate revenue growth rates for the business as a whole, (ii) individual product revenues, (iii) growth rates for the storage management software market, (iv) the aggregate size of the storage management software market, (v) anticipated product development and introduction schedules, (vi) product sales cycles, and (vii) the estimated life of a product's underlying technology. The estimated product development cycle for the new products ranged from 12 to 18 months. Operating expenses Operating expenses used in the valuation analysis of Arcada included (i) cost of goods sold, (ii) general and administrative expense, (iii) selling and marketing expense, and (iv) research and development expense. In developing future expense estimates, an evaluation of both Seagate Software and Arcada's overall business model, specific product results, including both historical and expected direct expense levels (as appropriate), and an assessment of general industry metrics was conducted. Cost of goods sold. Cost of goods sold, expressed as a percentage of revenue, for the developed and in-process technologies ranged from approximately 5% to 30% (30% for Desktop, 10% for NetWare, and 5% for Windows NT). Seagate Software's cost of goods sold was 20% for fiscal 1996, 22% for fiscal 1997, and 17% for fiscal 1998. General and administrative ("G&A") expense. G&A expense, expressed as a percentage of revenue, for the developed and in-process technologies ranged from 12% in calendar 1996 to 8% in calendar 1998 and beyond. Selling and marketing ("S&M") expense. S&M expense, expressed as a percentage of revenue, for the developed and in-process technologies was estimated to be 30% throughout the estimation period. Research and development ("R&D") expense. R&D expense consists of the costs associated with activities undertaken to correct errors or keep products updated with current information (also referred to as "maintenance" R&D). Maintenance R&D includes all activities undertaken after a product is available for general release to customers to correct errors or keep the product updated with current information. These 49 51 activities include routine changes and additions. The maintenance R&D expense was estimated to be 5% of revenue for the developed technologies and 3% of revenue for the in-process technologies throughout the estimation period. In addition, as of the date of acquisition, the Network & Storage Management Group management anticipated the costs to complete the Desktop, NetWare, and Windows NT technologies at approximately $6.8 million, $4.5 million, and $7.5 million, respectively. Since the acquisition date, all projects originally acquired from Arcada were commercially released prior to the end of the fourth quarter of fiscal 1997. Effective tax rate The effective tax rate utilized in the analysis of developed and in-process technologies was 38%, which reflects Seagate's combined federal and state statutory income tax rates, exclusive of non-recurring charges at the time of the acquisition and estimated for future years. Discount rate The discount rates selected for Arcada's developed and in-process technologies were 15% and 17.5%, respectively. In the selection of the appropriate discount rates, consideration was given to (i) the Weighted Average Cost of Capital (approximately 13% to 15% at the date of acquisition) and (ii) the Weighted Average Return on Assets (approximately 18%). The discount rate utilized for the in-process technology was determined to be higher than Seagate's WACC due to the fact that the technology had not yet reached technological feasibility as of the date of valuation. In utilizing a discount rate greater than Seagate's WACC, management has reflected the risk premium associated with achieving the forecasted cash flows associated with these projects. ACQUISITION OF SYTRON CORPORATION. In July 1995, Arcada Software, Inc., a majority-owned subsidiary of Arcada, acquired the assets and liabilities of Sytron Corporation, a company which developed, produced and marketed software products for data storage management. The purchase price of approximately $5,017,000 was paid in cash. Arcada accounted for the acquisition using the purchase method, and the results of operations of Sytron are only included in Seagate Software's operations since the acquisition was completed. The following is a summary of the purchase price allocation, in thousands: Current assets and other tangible assets.................... $ 848 Liabilities assumed......................................... (508) Developed technology........................................ 1,487 In-process research and development......................... 2,817 Goodwill.................................................... 373 ------ $5,017 ====== STOCKHOLDERS' EQUITY Seagate Software's authorized capital stock consists of 95,600,000 shares of common stock and 73,000,000 shares of preferred stock, 54,633,333 of which have been designated as Series A preferred stock and 18,366,667 of which remain undesignated. PREFERRED STOCK. The Series A preferred have the following rights, preferences and privileges: Conversion. The holders of the Series A preferred stock have the right to convert the Series A preferred stock at any time into common stock. The Series A preferred stock will be automatically converted into common stock, at the then-effective conversion price, upon the closing of a firm commitment underwritten public offering pursuant to an effective registration statement under the Securities Act of 1933, as amended. The initial conversion rate will be one share of preferred stock for each share of common stock. The 50 52 conversion price of the Series A preferred stock will be subject to adjustment to reduce the effect of dilution in the event that Seagate Software issues additional shares of common stock or equivalents. Voting. Each share of Series A preferred stock entitles the holder to one vote for each share of common stock into which such share could then be converted. Except as required by law, the holders of shares of Series A preferred stock and the holders of shares of common stock shall vote together as one class on all matters submitted to a vote of stockholders of Seagate Software. Dividend Preference. The holders of shares of Series A preferred stock shall be entitled to receive, when, as and if declared by the Board of Directors out of funds legally available for the purpose, an annual cash dividend in the amount of $0.45 per share (as adjusted to reflect any stock split, stock dividend, combination, recapitalization and the like (collectively a "Recapitalization") with respect to the Series A preferred stock), prior and in preference to any declaration or payment of any dividend (payable other than in common stock) on the common stock of Seagate Software. Such dividends shall not be cumulative, and no right shall accrue to holders of Series A preferred stock by reason of the fact that dividends on such shares are not declared or paid in any year. On the date that is the end of the first fiscal year in which Seagate Software recognizes net income after taxes, the holders of shares of Series A preferred stock shall be entitled to receive, out of funds legally available for the purpose, an annual cash dividend in the amount of $0.45 per share (as adjusted to reflect any Recapitalization) prior and in preference to any declaration or payment of any dividend (payable other than in common stock) on the common stock of Seagate Software (the "Cumulative Dividend"). The Cumulative Dividend shall accrue from the Cumulative Dividend Date and shall be payable only when, as and if determined by the Board, provided, that if the Cumulative Dividend shall not have been paid and a sum sufficient for the payment thereof set apart, the deficiency shall first be fully paid before any dividend or other distribution (other than dividends payable solely in common stock) shall be paid or declared and set apart for the common stock of Seagate Software. In the event any dividend shall be paid to the holders of common stock such dividend shall be distributed among the holders of the common stock and the Series A preferred stock in proportion to the shares of common stock then held by them and the shares of common stock which they then have the right to acquire upon the conversion of the Series A preferred stock held by them. Liquidation Preference. In the event of any liquidation, dissolution or winding up of Seagate Software or other reorganization, a distribution of $7.50 per share, as adjusted to reflect any Recapitalization of Series A preferred stock, plus all accrued or declared but unpaid dividends, if any, shall be made to the holders of Series A preferred stock before any amount shall be paid to the holders of common stock. DIVIDENDS. No dividends have been declared, or paid, to date by Seagate Software on any of the outstanding common stock or preferred stock. STOCK OPTION PLANS. The Option Plan provides for the issuance of either incentive or nonstatutory stock options to employees and consultants of Seagate Software. Seagate Software has reserved a total of 12,600,000 shares under the Plan. Options granted under Seagate Software's Plan are granted at fair market value, expire ten years from the date of the grant and vest over four years; 20% at the end of years one and two and 30% at 51 53 the end of years three and four. Following is a summary of stock option activity from the inception of the plan through the year ended July 3, 1998: OPTIONS OUTSTANDING -------------------------------------------------- NUMBER OF SHARES WEIGHTED AVERAGE EXERCISE PRICE ---------------- ------------------------------- Balance at June 30, 1995............ -- $ -- Granted........................... 3,276,200 4.00 Exercised......................... -- -- Canceled.......................... (45,088) 4.00 ---------- Balance at June 28, 1996............ 3,231,112 4.00 Granted........................... 2,851,255 5.42 Exercised......................... (20,855) 4.00 Canceled.......................... (973,733) 4.36 ---------- Balance at June 27, 1997............ 5,087,779 4.73 Granted........................... 8,039,707 9.04 Exercised......................... (892,212) 5.13 Canceled.......................... (1,299,143) 5.27 ---------- Balance at July 3, 1998............. 10,936,131 7.81 ========== Options available for grant were 750,802, 7,491,366 and 9,368,888 at the end of fiscal 1998, 1997 and 1996, respectively. The following tables summarize information about options outstanding at July 3, 1998. OPTIONS OUTSTANDING EXERCISABLE OPTIONS --------------------------------------- -------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE EXERCISE NUMBER OF CONTRACTUAL EXERCISE NUMBER EXERCISE PRICES SHARES LIFE (IN YEARS) PRICE OF SHARES PRICE -------- ---------- --------------- -------- --------- -------- $ 4.00................................... 2,288,427 8.0 $4.00 891,653 $4.00 $ 6.00................................... 3,860,158 9.0 6.00 305,374 6.00 $ 7.50 - 11.00........................... 2,043,397 9.6 8.83 11,760 7.86 $12.75................................... 2,744,149 10.0 12.75 -- -- ---------- --------- Total.................................. 10,936,131 9.1 7.81 1,208,787 4.54 ========== ========= PRO FORMA INFORMATION. In October 1995, the Financial Accounting Standards Board released Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS 123 provides an alternative to Accounting Principles Board Opinion 25, "Accounting for Stock Issued to Employees" ("APBO 25") and requires additional disclosures. Seagate Software has elected to follow APBO 25 in accounting for stock options granted. Under APBO 25, Seagate Software generally recognized no compensation expense with respect to such options. Pro forma information regarding net income and earnings per share is required by SFAS 123 for stock options granted after June 30, 1995 as if Seagate Software had accounted for its stock options under the fair value method of SFAS 123. The fair value of Seagate Software's stock options was estimated using a Black-Scholes option valuation model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, the Black-Scholes model requires the input of highly subjective assumptions, including the expected stock price volatility. Because Seagate Software's stock options granted to employees have characteristics significantly different from those of exchange-traded options (and are not fully transferable) and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the Black-Scholes model does not necessarily provide a reliable single measure of the fair value of its stock options granted to employees. The fair value of Seagate Software's stock options granted to employees was estimated assuming no expected dividends and the following weighted average assumptions: 52 54 SEAGATE SEAGATE SOFTWARE TECHNOLOGY INCENTIVE EMPLOYEE STOCK STOCK OPTION PURCHASE PLAN SHARES PLAN SHARES -------------------- -------------------- 1998 1997 1996 1998 1997 1996 ---- ---- ---- ---- ---- ---- Expected life (in years).......................... 3.67 3.65 3.65 .56 .50 .50 Risk-free interest rate........................... 5.7% 6.2% 5.6% 5.5% 5.4% 5.4% Volatility........................................ .55 .55 .55 .63 .46 .46 The weighted average exercise price and weighted average fair value of stock options granted in 1998 under Seagate Software's Plan were $9.04 and $4.20 per share, respectively. The weighted average purchase price and weighted average fair value of shares granted in 1998 under the Seagate Technology Employee Stock Purchase Plan (the "Purchase Plan") were $26.99 and $12.03, respectively. For purposes of pro forma disclosures, the estimated fair value of the options is amortized over the options' vesting period (for stock options) and over the six-month purchase period for stock purchases under the Purchase Plan. Pro forma net loss per common share for 1996 is not presented because Seagate Software's current capital structure did not exist prior to April 1996, making presentation for prior periods not meaningful. Seagate Software's pro forma information follows, in thousands: 1998 1997 1996 -------- -------- --------- Net loss.......................................... $(16,496) $(57,831) $(130,043) Net loss per common share......................... $(100.24) $(854.05) The effects on pro forma disclosures of applying SFAS 123 are not likely to be representative of the effects on pro forma disclosures of future years. Because SFAS 123 is applicable only to options granted subsequent to June 30, 1995, and Seagate Software did not commence granting stock options for the purchase of Seagate Software common stock until June 1996, the pro forma effect will not be fully reflected until 2000. INCOME TAXES Seagate Software is included in the consolidated federal and certain combined and consolidated foreign and state income tax returns of Seagate Technology. Seagate Technology and Seagate Software have entered into a tax sharing agreement (the "Tax Allocation Agreement") pursuant to which Seagate Software computes hypothetical tax returns (with certain modifications) as if Seagate Software was not included in consolidated or combined returns with Seagate Technology. Seagate Software must pay Seagate Technology the positive amount of any such hypothetical taxes. If the hypothetical tax returns show entitlement to refunds, including any refunds attributable to a carryback, then Seagate Technology will pay Seagate Software the amount of such refunds. At the end of fiscal 1998, $8,500,000 in intercompany tax-related balances was due from Seagate Software to Seagate Technology. At the end of fiscal 1997 and 1996, there were no intercompany tax-related balances outstanding between Seagate Software and Seagate Technology. The (benefit from) provision for income taxes consisted of the following, in thousands: 1998 1997 1996 ------- ------- ------- Current Tax Expense Federal............................................. $ 9,444 $(5,007) $(7,196) State............................................... 1,575 (384) (762) Foreign............................................. 8,908 4,182 996 ------- ------- ------- Total Current Tax Expense............................. 19,927 (1,209) (6,962) Deferred Tax Expense Federal............................................. (3,831) (6,330) (1,498) State............................................... (711) (1,175) (288) ------- ------- ------- Total Deferred Tax Expense............................ (4,542) (7,505) (1,786) ------- ------- ------- (Benefit from) Provision for Income Taxes............. $15,385 $(8,714) $(8,748) ======= ======= ======= 53 55 The (benefit from) provision for income taxes has been computed on a separate return basis (with certain modifications), except that pursuant to the Tax Allocation Agreement, the tax benefits of certain of Seagate Software's fiscal 1997 and 1996 tax losses and credits were recognized in the year such losses and credits were utilized by Seagate Technology in its tax returns. In fiscal 1998, Seagate Software did not recognize the benefit of certain tax credits because they were not expected to be utilized by Seagate Technology in its tax returns. The pro forma information assuming a tax benefit based on a separate return basis is as follows, in thousands: YEAR ENDED JULY 3, 1998 ------------ Income before provision for income taxes................. $6,115 Provision for income taxes............................... 4,548 ------ Net income............................................... $1,567 ====== The income tax benefits related to the exercise of employee stock options reduced amounts due to or increased amounts due from Seagate Technology pursuant to the Tax Allocation Agreement and were credited to additional paid-in capital. Such amounts approximated $770,000, $3,486,000 and $1,866,000 in 1998, 1997 and 1996, respectively. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The significant components of Seagate Software's deferred tax assets and liabilities were as follows, in thousands: 1998 1997 -------- -------- DEFERRED TAX ASSETS Receivable reserves.................................... $ 1,951 $ 1,859 Accrued warranty....................................... 244 192 Inventory write-downs not currently deductible......... 504 299 Accrued compensation and benefits...................... 1,329 1,517 Depreciation........................................... (986) 827 Accrued restructuring.................................. -- 963 Accrued expenses not currently deductible.............. 2,532 850 Acquisition related items.............................. 36,264 34,745 Domestic and foreign net operating loss carryforwards........................................ 13,116 13,098 Tax credit carryforwards............................... 8,686 1,155 Other.................................................. 2,164 2,372 -------- -------- Total Deferred Tax Assets............................ 65,804 57,877 Valuation allowance.................................... (65,804) (57,877) -------- -------- Net Deferred Tax Assets.............................. -- -- ======== ======== DEFERRED TAX LIABILITIES Acquisition related items.............................. (1,691) (6,233) -------- -------- Total Deferred Tax Liabilities....................... (1,691) (6,233) -------- -------- Net Deferred Tax Liabilities........................... $ (1,691) $ (6,233) ======== ======== A valuation allowance has been provided for the deferred tax assets as of the end of fiscal 1998 and 1997. Realization of the deferred tax assets is dependent on future earnings, the timing and amount of which are uncertain. In addition, the net operating loss and tax credit carryforwards of acquired subsidiaries are subject to further limitations on utilization due to the "change in ownership" provisions of Internal Revenue Code Section 382 and the "separate return limitation year" rules of the federal consolidated return regulations. Approximately $8,213,000 of the valuation allowance in fiscal 1998 and 1997 is attributable to deferred tax assets that when realized, will reduce unamortized goodwill or other intangible assets of the acquired 54 56 subsidiaries. The valuation allowance increased by $7,927,000, $11,946,000 and $26,038,000 in 1998, 1997 and 1996, respectively. As of June 27, 1997, Seagate Software has domestic and foreign net operating loss carryforwards of approximately $37,515,000 expiring in 2003 through 2010 if not used to offset future taxable income. In addition, Seagate Software, as of July 3, 1998, has research and development tax credit carryforwards of approximately $1,155,000 expiring in 2005 through 2011 and foreign tax credit carryforwards of $7,351,000, expiring in 2003, if not used to offset future tax liabilities. The reconciliation between the (benefit from) provision for income taxes at the U.S. statutory rate and the effective rate is summarized as follows, in thousands: 1998 1997 1996 ------- -------- -------- (Benefit) provision at U.S. statutory rate.......... $ 2,140 $(21,937) $(48,446) State income taxes (benefit), net................... 393 (382) (762) Foreign taxes in excess of the U.S. statutory rate.............................................. 2,084 255 25 In-process research and development................. -- -- 15,382 Goodwill and other acquisition related items........ 2,894 4,358 2,833 Valuation allowance................................. 7,927 8,871 22,216 Other............................................... (53) 121 4 ------- -------- -------- $15,385 $ (8,714) $ (8,748) ======= ======== ======== Cumulative undistributed earnings of certain foreign operations of Seagate Software of $2,633,000 are considered to be permanently invested in non-U.S. operations. No U.S. federal and state income tax has been provided on these amounts. Additional U.S. federal and state income taxes that would have to be provided if these earnings were repatriated to the U.S. cannot be determined at this time. RESTRUCTURING COSTS Restructuring charges were $9.5 million in fiscal 1996 and $2.5 million in fiscal 1997. The 1996 restructuring charges pertain to the acquisition of Arcada Holdings, Inc. in February 1996. As a result of the acquisition, Seagate Software had obtained duplicate technologies and product lines in data protection and storage management software as those assets acquired in the Palindrome Corporation (Palindrome) acquisition in fiscal 1995. Seagate Software determined that it would be beneficial to consolidate the world-wide sales, marketing, research and development, technical support and other operations and administrative functions of its network and storage management business. A restructuring plan was approved by the Board of Directors in March 1996 and the plan resulted in facility closures and staff reductions of 43 at the Arcada facilities in Westboro, Massachusetts, the United Kingdom and France, as well as staff reductions of 69 at the former Palindrome facility in Naperville, Illinois. In addition, because Arcada had a better industry reputation and superior products to those of Palindrome, Seagate Software's plan and strategy going forward was to focus on the technologies and products acquired from Arcada. The revenue and net operating loss relating to products acquired from Palindrome in fiscal 1996 was $15.9 million and $2.1 million respectively. For fiscal 1997, the revenue and net operating loss relating to products acquired from Palindrome was $3.3 million and $3.7 million respectively. The non-cash restructuring charges included amounts for abandonment of the Palindrome trademarks, impairment of the capitalized workforce intangible assets pertaining to the acquisition of Palindrome because of the planned layoff of personnel, write-off of a duplicate trade show booth, and write-off of obsolete Palindrome marketing materials. Cash restructuring charges included amounts for severance and benefits to terminated Palindrome employees, costs for facilities lease termination, other contract cancellation fees, and merger related costs incurred by Arcada in the acquisition of the Arcada minority interests by Seagate Technology. The fiscal 1997 restructuring charges netted to $2.5 million, comprised of a $3.4 million restructuring charge that included the closure of Seagate Software's Network & Storage Management Group's facility 55 57 located in Cupertino, California. This facility closure resulted in cash charges for severance and benefits for 69 employee terminations and non-charges for excess facilities and the write down of equipment. In addition, the $3.4 million included amounts related to the Company's decision, after concluding a sale was no longer viable, to no longer pursue the technologies acquired in the 1996 acquisition of Calypso Software Systems, Inc. and to shutdown its operations. This decision resulted in cash charges for severance and benefits for 35 employee terminations and non-cash charges for the write off of certain remaining intangible assets of Calypso. The revenue and net operating loss relating to Calypso for fiscal 1996 was $444,000 and $53,000 respectively. For fiscal 1997, the revenue and net operating loss relating to Calypso was $640,000 and $47,000 respectively. The restructuring charges recorded in fiscal 1997 were reduced by $957,000 for the reversal of amounts pertaining to the fiscal 1996 restructuring charges as a result of a higher than planned number of voluntary employee terminations without severance benefits prior to the facility shutdown and completion of other aspects of the restructuring plan at less than the originally estimated cost, net of an increase in the accrual for facilities lease payments due to changes in estimates of the costs to terminate leases after facilities closure. A summary of Seagate Software's restructuring activities for the past three years is provided below (in thousands): SEVERANCE AND CONTRACT LEGAL AND EMPLOYEE CANCELLATION ACCOUNTING OTHER BENEFITS FACILITIES EQUIPMENT INVENTORY INTANGIBLES FEES FEES EXPENSES --------- ---------- --------- --------- ----------- ------------ ---------- -------- 1996 charges......... $1,554 $1,571 $ 1,018 $ 300 $ 4,312 $ 67 $ 525 $ 155 Cash charges......... (518) -- -- -- -- -- (568) -- Non-cash charges..... -- (121) (116) -- (4,052) -- -- (138) ------ ------ ------- ----- ------- ---- ----- ----- Reserves 1996........ 1,036 1,450 902 300 260 67 (43) 17 1997 charges......... 770 505 728 -- 1,378 -- -- 100 Cash charges......... (975) (915) -- -- -- -- -- -- Non-cash charges..... -- (72) (44) -- (1,378) -- -- -- Adjustment........... (351) 267 (172) (300) (260) (67) 43 (117) ------ ------ ------- ----- ------- ---- ----- ----- Reserves 1997........ 480 1,235 1,414 -- -- -- -- -- Cash charges......... (373) (519) (9) -- -- -- -- -- Non-cash charges..... -- -- (1,045) -- -- -- -- -- Adjustment........... (107) 467 (360) -- -- -- -- -- ------ ------ ------- ----- ------- ---- ----- ----- Reserves 1998........ $ -- $1,183 $ -- $ -- $ -- $ -- $ -- $ -- ====== ====== ======= ===== ======= ==== ===== ===== TOTAL ------- 1996 charges......... $ 9,502 Cash charges......... (1,086) Non-cash charges..... (4,427) ------- Reserves 1996........ 3,989 1997 charges......... 3,481 Cash charges......... (1,890) Non-cash charges..... (1,494) Adjustment........... (957) ------- Reserves 1997........ 3,129 Cash charges......... (901) Non-cash charges..... (1,045) Adjustment........... -- ------- Reserves 1998........ $ 1,183 ======= Seagate Software's remaining restructuring reserves pertain to continuing lease payments on facilities that were closed and abandoned as a result of the Palindrome restructuring. Seagate Software has been unable to sublease these facilities and anticipates that the remaining restructuring reserves will be utilized over the period through lease termination in fiscal 2002. In fiscal 1996, Seagate Software recorded a restructuring reserve of $9,502,000 for the following items: Severance and employee benefits ($1,554,000) -- Severance and employee benefits included amounts for consolidation of operations and termination of employees at the Arcada facilities in Westboro, Massachusetts, the United Kingdom and France, as well as at the former Palindrome facility in Naperville, Illinois. Excess facilities ($1,571,000) -- This accrual was designed to provide for rent termination costs and rent expense for facilities located in Naperville, Westboro, the United Kingdom and France that are to be closed as a result of the restructuring actions. Equipment ($1,018,000) -- This amount is a reserve for equipment at the Naperville, Westboro, the United Kindgom and France facilities. It consists of computer equipment, furniture and fixtures and software at these facilities that will not be used after the locations are closed. All of the equipment provided for in this reserve has been abandoned. Inventory ($300,000) -- This consists of obsolete packaging material that will no longer be used and OEM inventory of $80,000 that will no longer be sold. 56 58 Intangibles ($4,312,000) -- This write down consists of Palindrome intangible assets of $3,534,000, $390,000 of developed technology related to Atlas and $388,000 of goodwill related to the Sytron acquisition. The Palindrome intangible assets were further broken down into trademark of $1,000,000, workforce of $1,188,000, distribution network of $69,000 and goodwill of $1,277,000. Seagate Software decided to pursue the Arcada brand name and trademark and abandon the Palindrome trademark. As a result, Seagate Software determined that it would lay off substantially all of the 121 employees of Palindrome located at the Naperville facility. At the time of original purchase, Seagate Software proportionally allocated goodwill to long-lived intangible assets based upon the original purchase price. The amounts of goodwill included in the restructuring reserve relate to the remaining unamortized goodwill associated with the intangible assets written off. Contract Cancellation ($67,000) -- This $67,000 item is a canceled contract for outsourced Technical Support with a vendor used by Palindrome. Legal/Accounting Fees ($525,000) -- This $525,000 represents and estimate of the legal and accounting fees that were to be incurred by Arcada from the acquisition of Arcada stock by Seagate Technology. Other ($155,000) -- This represents a trade show booth valued at $100,000 that is redundant and $55,000 worth of obsolete marketing materials. The above assets were not impaired in a prior period because their impairment arose specifically from the restructuring actions taken as a result of the acquisition of the minority interest in Arcada in the third quarter of fiscal 1996. Prior to the acquisition, Palindrome products were marketed and sold as part of the Seagate Software portfolio. Seagate Software has not generated any income from these activities in subsequent periods. In fiscal 1997, Seagate Software recorded an additional restructuring reserve of $3,481,000 that resulted primarily from the plan to shutdown Manchester operations and the decision to try to sell the Calypso technology and a separate decision to consolidate Network & Storage Management Group operations which resulted in the shutdown of Seagate Software's facility in Cupertino, California. Severance and employee benefits ($770,000) -- Severance and employee benefits included amounts for the shutdown and termination of employees at the Cupertino, California facility due to a consolidation of operations and the shutdown and termination of employees at the Calypso facility in Manchester, New Hampshire due to a decision to no longer pursue the Calypso products and technologies. Excess facilities ($505,000) -- This accrual was designed to provide for rent termination costs and rent expense for facilities closures in Manchester, New Hampshire and Cupertino, California. Equipment ($728,000) -- This equipment is in the Manchester and Cupertino facilities that would not be used after the shutdowns. It consisted largely of computer equipment but also included amounts for furniture and fixtures and software. All of the equipment provided for in this reserve has been abandoned. Intangibles ($1,378,000) -- This asset consisted of Calypso related intangibles first capitalized upon the acquisition of Calypso in fiscal 1996. The amounts written down included net developed technology of $1,086,000 and assembled workforce of $292,000. These assets were written down based on management's plan to sell Calypso and its products and technologies. Other ($100,000) -- This represents miscellaneous additional costs related to the Manchester (Calypso) shutdown. The above assets were not impaired in a period prior to recording the restructuring reserves because their impairment arose specifically from the business decision and plan in the fourth quarter of fiscal 1997 to close the Manchester (Calypso) facility and abandon that technology and the additional decision to consolidate operations of the company and close the Cupertino facility. LINES OF CREDIT In addition to the Revolving Loan Agreement with Seagate Technology, certain foreign subsidiaries have line of credit facilities with third party financial institutions. These line of credit facilities provide for additional 57 59 borrowings of up to an equivalent of approximately $1,100,000 at July 3, 1998. Interest rates payable on borrowings are based on local bank prime interest rates. At July 3, 1998, there were no outstanding borrowings under any of these lines of credit. BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION Seagate Software operates in a single industry segment by developing, marketing and supporting business intelligence and systems infrastructure management software products, and related professional services. The following tables summarize Seagate Software's operations in different geographic areas, in thousands: YEAR ENDED JULY 3, 1998 ------------------------------------------------- ADJUSTMENTS NORTH AND AMERICA EUROPE ELIMINATIONS CONSOLIDATED -------- -------- ------------ ------------ Revenues from unaffiliated customers.... $275,606 $ 17,620 $ -- $293,226 Transfers between geographic areas...... 2,368 30 (2,398) -- -------- -------- ------- -------- Total net sales......................... $277,974 $ 17,650 (2,398) $293,226 Income (loss) from operations........... 19,954 (13,829) -- 6,125 Other income (expense), net............. 287 (297) -- (10) -------- -------- ------- -------- Income (loss) before income taxes....... $ 20,241 $(14,126) $ -- $ 6,115 -------- -------- ------- -------- Identifiable assets..................... $114,086 $ 24,911 $ -- $138,997 ======== ======== ======= ======== YEAR ENDED JUNE 27, 1997 ------------------------------------------------ ADJUSTMENTS NORTH AND AMERICA EUROPE ELIMINATIONS CONSOLIDATED -------- ------- ------------ ------------ Revenues from unaffiliated customers.... $203,324 $13,626 $ -- $216,950 Transfers between geographic areas...... 861 841 (1,702) -- -------- ------- ------- -------- Total net sales......................... $204,185 $14,467 $(1,702) $216,950 Loss from operations.................... (55,225) (5,071) -- (60,296) Other expense, net...................... (2,315) (66) -- (2,381) -------- ------- ------- -------- Loss before income taxes................ $(57,540) $(5,137) $ -- $(62,677) ======== ======= ======= ======== Identifiable assets..................... $107,617 $39,714 $ -- $147,331 ======== ======= ======= ======== YEAR ENDED JUNE 28, 1996 -------------------------------------------------- ADJUSTMENTS NORTH AND AMERICA EUROPE ELIMINATIONS CONSOLIDATED --------- -------- ------------ ------------ Revenues from unaffiliated customers........................... $ 139,123 $ 2,463 $ -- $ 141,586 Transfers between geographic areas.... 312 -- (312) -- --------- -------- ----- --------- Total net sales....................... $ 139,435 $ 2,463 $(312) $ 141,586 Loss from operations.................. (102,273) (35,533) -- (137,806) Other income (expense), net........... (644) 34 -- (610) --------- -------- ----- --------- Loss before income taxes.............. $(102,917) $(35,499) $ -- $(138,416) ========= ======== ===== ========= Identifiable assets................... $ 155,730 $ 45,868 $ -- $ 201,598 ========= ======== ===== ========= The loss from operations includes net revenues less operating expenses. The loss from operations in Europe for the year ended June 28, 1996 is primarily related to the write-off of $35,892,000 of in-process research and development in connection with the Holistic acquisition. The loss from operations in Europe for the year ended June 27, 1997 includes approximately $7,662,000 of amortization of intangible assets relating to the Holistic acquisition and $2,613,000 relating to the write-off of in-process research and development for contingent payments made to the former shareholders of Holistic during 1997. The loss from operations in Europe for the year ended July 3, 1998 includes approximately $9,138,000 of amortization of intangible assets 58 60 relating to the Holistic acquisition. The identifiable assets by geographic area are those assets used in Seagate Software's operations in each area. Seagate Software generated export revenues from the United States of approximately $66,250,000, $44,129,000 and $33,617,000 in 1998, 1997 and 1996, respectively. COMMITMENTS LEASES. Seagate Software leases certain property, facilities and equipment under non-cancelable lease agreements. Facility leases expire at various dates through 2008 and contain various provisions for rental adjustments. The leases require Seagate Software to pay property taxes, insurance and normal maintenance costs. Seagate Software also occupies certain facilities owned by Seagate Technology. Future minimum payments for operating leases were as follows at July 3, 1998, in thousands: OPERATING LEASES --------- 1999....................................................... $ 8,918 2000....................................................... 7,581 2001....................................................... 5,507 2002....................................................... 4,953 2003....................................................... 3,866 After 2003................................................. 35,992 ------- $66,817 ======= Total rent expense for all facility and equipment operating leases was approximately $8,023,000, $5,292,000 and $3,181,000 for 1998, 1997 and 1996, respectively. NON-CANCELABLE CAPITAL OBLIGATIONS. Non-cancelable capital obligations totaled $384,291 as of July 3, 1998. LEGAL PROCEEDINGS On November 10, 1997, Vedatech Corporation commenced an action in the High Court of Justice Chancery Division in the United Kingdom against Seagate Software Information Management Group Ltd. claiming breach of an oral agreement and infringement of a Vedatech U.K. copyright in the Japanese translation of one of Seagate Software's products (the "Complaint") and seeking monetary and injunctive relief. No specific damage amount has yet been claimed. Seagate Software has hired local counsel in the U.K., reviewed documents and conducted interviews. Seagate Software filed an initial response in the U.K. court on January 13, 1998 and is now in the discovery process. Seagate Software believes the Complaint has no merit and intends to vigorously defend the action. However, if an unfavorable outcome were to arise, there can be no assurance that such outcome would not have a material adverse effect on Seagate Software's liquidity, financial position or results of operations. In addition to the foregoing, Seagate Software is engaged in legal actions arising in the ordinary course of its business and believes that the ultimate outcome of these actions will not have a material adverse effect on Seagate Software's financial position, liquidity or results of operations. 59 61 QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Summarized quarterly financial information for fiscal years 1998 and 1997 are summarized below: The quarterly information for 1998 and 1997 has been restated to reflect the adjustment described in the Summary of Significant Accounting Policies note. AS REPORTED ----------------------------------------------------- 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER ----------- ----------- ----------- ----------- Fiscal year 1998 Net revenues............................. $ 63,022 $ 72,344 $ 78,588 $ 79,272 Gross profit............................. 49,226 60,842 65,314 67,384 Income (loss) from operations............ (3,399) 1,343 7,015 1,946 Net income (loss)........................ (2,915) 2,353 1,757 (9,685) Basic net income (loss) per share........ (28.12) 15.30 9.22 (46.08) Diluted net income (loss) per share...... (28.12) 0.04 0.03 (46.08) AS RESTATED ----------------------------------------------------- 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER ----------- ----------- ----------- ----------- Fiscal year 1998 Net revenues............................. $ 63,022 $ 72,344 $ 78,588 $ 79,272 Gross profit............................. 49,226 60,842 65,314 67,384 Income (loss) from operations............ (3,594) 1,148 6,820 1,751 Net income (loss)........................ (3,110) 2,158 1,562 (9,880) Basic net income (loss) per share........ (30.00) 14.03 8.19 (47.01) Diluted net income (loss) per share...... (30.00) 0.04 0.03 (47.01) AS REPORTED ----------------------------------------------------- 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER ----------- ----------- ----------- ----------- Fiscal year 1997 Net revenues............................. $ 51,463 $ 55,136 $ 54,174 $ 56,177 Gross profit............................. 39,837 43,328 39,777 46,219 Loss from operations..................... (7,608) (9,187) (37,182) (10,056) Net loss................................. (7,864) (8,669) (27,636) (13,531) Basic and diluted net loss per share..... (125.82) (138.70) (442.18) (162.33) AS RESTATED ----------------------------------------------------- 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER ----------- ----------- ----------- ----------- Fiscal year 1997 Net revenues............................. $ 51,463 $ 55,136 $ 54,174 $ 56,177 Gross profit............................. 39,837 43,328 39,777 46,219 Loss from operations..................... (6,523) (8,053) (35,469) (10,251) Net loss................................. (6,779) (7,535) (25,923) (13,726) Basic and diluted net loss per share..... (108.46) (120.56) (414.77) (164.67) 60 62 The following reconciles previously reported amounts to restated amounts by quarter for the years ended July 3, 1998 and June 27, 1997: 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER ----------- ----------- ----------- ----------- Fiscal year 1998 Net income (loss) as originally reported........................... $(2,915) $ 2,353 $ 1,757 $(9,685) Increase in the amortization of goodwill and intangibles........... (195) (195) (195) (195) ------- ------- ------- ------- Net income (loss) as restated......... $(3,110) $ 2,158 $ 1,562 $(9,880) ======= ======= ======= ======= 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER ----------- ----------- ----------- ----------- Fiscal year 1997 Net loss as originally reported....... $(7,864) $(8,669) $(27,636) $(13,531) Reversal of goodwill write-offs and write-downs........................ 1,085 1,184 1,817 -- Increase in the amortization of goodwill and intangibles........... -- (50) (104) (195) ------- ------- -------- -------- Net loss as restated.................. $(6,779) $(7,535) $(25,923) $(13,726) ======= ======= ======== ======== ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 61 63 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS The directors and executive officers of Seagate Software and certain information about them as of September 2, 1998, are as follows: DIRECTOR OR EXECUTIVE NAME AGE POSITION OFFICER SINCE ---- --- -------- ------------- Stephen J. Luczo....... 41 Chairman of the Board of Directors 1996 Gary B. Filler......... 57 Director 1996 Lawrence Perlman....... 60 Director 1996 Donald L. Waite........ 65 Director 1996 Terence R. 39 President and Chief Operating Officer 1996 Cunningham........... Gregory B. Kerfoot..... 38 Chief Strategic Officer 1996 Ellen E. Chamberlain... 41 Senior Vice President, Treasurer and Chief 1996 Financial Officer Mr. Luczo currently serves as Chairman of the Board of Directors of Seagate Software and as Chief Executive Officer, President and Director of Seagate Technology. Prior to becoming the Company's Board Chairman in July 1997, Mr. Luczo served as the Company's Chief Operating Officer between March 1995 and July 1997. Mr. Luczo joined Seagate Technology in October 1993 as Senior Vice President, Corporate Development and was promoted to Executive Vice President, Corporate Development in March 1995, where he served until September 1997. He was promoted to President and Chief Operating Officer in September 1997, serving in the latter capacity until August 1998. In July 1998, Mr. Luczo was promoted to Chief Executive Officer and appointed to the Board of Directors. Before joining Seagate Technology in 1993, Mr. Luczo was Senior Managing Director and Co-head of the Bear Stearns and Co. Global Technology Group from February 1992 to October 1993. Mr. Luczo also serves on the Boards of Directors of Gadzoox Microsystems, Inc. and Dragon Systems, Inc. Mr. Filler currently serves as a Director of the Company and as Co-chairman of the Board of Directors of Seagate Technology. Mr. Filler has held various positions on Seagate Technology's Board of Directors, including Vice Chairman from October 1990 until September 1991, Chairman from September 1991 until October 1992, and Co-chairman since July 1998. Mr. Filler has been a financial consultant since September 1996. He was Senior Vice President and Chief Financial Officer of Diamond Multimedia Systems, Inc., a multimedia and graphics company, from January 1995 to September 1996. From June 1994 to January 1995, Mr. Filler was a business consultant and private investor. From February 1994 until June 1994, he served as Executive Vice President and Chief Financial Officer of ASK Group, Inc., a computer systems company. Mr. Filler also serves on the Board of Directors of Sento Corporation. Mr. Perlman currently serves as a Director of the Company and as Co-chairman of the Board of Directors of Seagate Technology. He was appointed Chairman of the Board of Directors of Ceridian Corporation (formerly Control Data Corporation), a technology-based services company, in November 1992. Mr. Perlman previously held several executive positions at Ceridian Corporation, including President and Chief Executive Officer of Imprimis Technology Incorporated, a subsidiary of Control Data Corporation. He was a regent of the University of Minnesota from 1992 to 1995. Mr. Perlman also serves on the Boards of Directors of Computer Network Technology Corporation, AMDOCS Limited, and Valspar Corporation. Mr. Waite currently serves as a Director of the Company and as Executive Vice President, Chief Administrative Officer, and Assistant Secretary of Seagate Technology. Since joining Seagate Technology in 1983, Mr. Waite has served in various roles, including Chief Financial Officer from 1983 to February 1998. He has served as Executive Vice President and Chief Administrative Officer since March 1995 and as Assistant Secretary since July 1998. Mr. Waite also serves on the Boards of Directors of California Micro Devices and CVC Holdings, Inc. 62 64 Mr. Cunningham currently serves as the Company's President and Chief Operating Officer and as Executive Vice President and General Manager of NSMG. He founded Crystal Computer Services, Inc. ("Crystal") in 1984 and served as its President. In May 1994 he joined Seagate Technology in connection with its acquisition of Crystal and continued as Crystal's President until May 1996, when he was named President of the Storage Management Group. Later in 1996, he was named Executive Vice President and General Manager of Seagate Software NSMG. Since fiscal 1998 Mr. Cunningham has served as President and Chief Operating Officer for the Company as well as Executive Vice President and General Manager of NSMG. In his role as President and Chief Operating Officer of the Company, Mr. Cunningham is responsible for the day to day operations of Seagate Software and serves in a role functionally equivalent to that of a chief executive officer of a corporation. Mr. Kerfoot currently serves as the Company's Chief Strategic Officer and as Executive Vice President and General Manager of IMG. He joined Crystal in September 1988 as the Director of Research and Development and Chief Architect of Crystal Reports. In May 1994 he joined Seagate Technology in connection with its acquisition of Crystal and continued as Crystal's Director of Research and Development until May 1996, when he was named President of the Information Management Group. Later in 1996, he was named Executive Vice President and General Manager of Seagate Software IMG. Since fiscal 1998 Mr. Kerfoot has served as Chief Strategic Officer for the Company as well as Executive Vice President and General Manager of IMG. Ms. Chamberlain currently serves as the Company's Senior Vice President, Treasurer, and Chief Financial Officer. She joined Seagate Technology in March 1985 and served in various finance positions, including Vice President and Treasurer between November 1994 and February 1996. In March 1994, Ms. Chamberlain began simultaneously supporting the development of the Company. She served as the Company's Vice President between April and December 1996, when she was promoted to Senior Vice President and Chief Financial Officer. Ms. Chamberlain was also promoted to Treasurer of the Company in fiscal 1998 after serving as its Assistant Treasurer since April 1996. 63 65 ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table sets forth the compensation paid by the Company to the President and to the three next most highly compensated executive officers of the Company (the "Named Executive Officers") whose compensation exceeded $100,000 in the fiscal year ended July 3, 1998. LONG-TERM COMPENSATION ------------ SECURITIES UNDERLYING NAME AND FISCAL OTHER ANNUAL OPTIONS PRINCIPAL POSITION YEAR SALARY($) BONUS($) COMPENSATION($) GRANTED(1) ------------------ ------ --------- -------- --------------- ------------ Stephen J. Luczo................... 1998 $ 92,756(2) $ -- $ 2,971(2) 150,000 Chairman of the Board of Directors 1997 100,000(2) 195,000(2) 1,659(2) 80,000 Terence R. Cunningham.............. 1998 155,002 803,800(3) -- 550,000 President and Chief Operating Officer 1997 150,530 537,127(3) -- 100,000 Gregory B. Kerfoot................. 1998 151,450 803,800(3) -- 550,000 Chief Strategic Officer 1997 139,947 953,292(3) -- 100,000 Ellen E. Chamberlain............... 1998 155,002 391,500(3) 12,000 127,500 Senior Vice President, Treasurer, and 1997 155,000 221,500(4) 6,000 28,000 Chief Financial Officer - --------------- (1) The stock options listed in the table represent options to purchase Common Stock of the Company. See "Executive Compensation -- Option Grants in Fiscal 1998" for additional information regarding options to purchase stock of the Company granted during fiscal year 1998. (2) Amount represents the percentage of Mr. Luczo's salary that directly benefited the Company. This amount was directly paid by the Company to Seagate Technology under a General Services Agreement. See Pushdown and Carveout Accounting note to the Consolidated Financial Statements. (3) Includes amounts earned under the Company's executive bonus plan. (4) Includes amounts deferred under Seagate Technology's compensation plan. 64 66 OPTION GRANTS IN 1998 The following table sets forth certain information concerning grants of stock options to each of the Company's Named Executive Officers during the fiscal year ended July 3, 1998. POTENTIAL REALIZABLE VALUE AT NUMBER OF ASSUMED ANNUAL RATES OF SECURITIES % OF TOTAL EXERCISE STOCK PRICE APPRECIATION FOR UNDERLYING OPTIONS GRANTED OR BASE OPTION TERM(4) OPTIONS TO EMPLOYEES IN PRICE PER EXPIRATION ----------------------------- NAME GRANTED(1) FISCAL YEAR SHARE(2) DATE 5% 10% ---- ---------- --------------- --------- ---------- ------------- ------------- Stephen J. Luczo........ 50,000 0.62% $6.00(3) 08/29/07 $ 188,668 $ 478,123 50,000 0.62% 8.75(3) 02/02/08 275,141 697,262 50,000 0.62% 12.75(3) 07/01/08 400,920 1,016,011 Terence R. Cunningham... 200,000 2.49% 6.00(3) 08/29/07 754,674 1,912,491 100,000 1.24% 8.75(3) 02/02/08 550,283 1,394,525 250,000 3.11% 12.75(3) 07/01/08 2,004,602 5,080,054 Gregory B. Kerfoot...... 200,000 2.49% 6.00(3) 08/29/07 754,674 1,912,491 100,000 1.24% 8.75(3) 02/02/08 550,283 1,394,525 250,000 3.11% 12.75 07/01/08 2,004,602 5,080,054 Ellen E. Chamberlain.... 40,000 0.50% 6.00(3) 08/29/07 150,935 382,498 25,000 0.31% 8.75(3) 02/02/08 137,571 348,631 62,500 0.78% 12.75(3) 07/01/08 501,150 1,270,014 - --------------- (1) All stock options granted in fiscal 1998 vest over four years; 20% at the end of years one and two and 30% at the end of years three and four. Under the Option Plan, the Company's Board retains discretion to modify the terms, including the price, of outstanding options. (2) Options were granted at an exercise price equal to the fair market value of the Company's Common Stock on the grant date, as determined by the Compensation Committee of the Board of Directors of Seagate Software. To determine the fair market value of the Company's Common Stock, the Compensation Committee of the Board of Directors considers a number of factors, including, but not limited to, the Company's current financial performance and prospects for future growth and profitability, the status of product releases and product integration, the absence of a resale market for the Company's Common Stock, the liquidity preferences of the Company's Series A Preferred Stock, the control position held by Seagate Technology, and comparisons of certain key valuation metrics for the Company with similar metrics for comparable publicly traded companies, including measures of market capitalization based on revenue multiples, price-to-earnings ratios and operating margins. (3) Exercise price and withholding obligations may be paid in cash or by delivery of already-owned shares subject to certain conditions. (4) Potential realizable value is based on the assumption that the Company's Common Stock appreciates at the annual rate shown (compounded annually) from the date of grant until the expiration of the ten year option term. These numbers are calculated based on the requirements promulgated by the Securities and Exchange Commission and do not reflect the Company's estimate of future stock price growth. 65 67 AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES The following table sets forth certain information regarding the exercise of stock options in the last fiscal year by the persons named in the Summary Compensation Table and the value of options held by such individuals at the end of the fiscal year. NUMBER OF SECURITIES VALUE OF UNEXERCISED NUMBER OF UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS SHARES VALUE OPTIONS AT 1998 YEAR END AT 1998 YEAR END(2) ACQUIRED RECEIVED --------------------------- --------------------------- NAME ON EXERCISE $(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ---- ----------- -------- ----------- ------------- ----------- ------------- Stephen J. Luczo........ -- $ -- 34,000 216,000 $245,500 $1,007,000 Terence R. Cunningham... 400,000 200,000 -- 350,000 -- 400,000 Gregory B. Kerfoot...... -- -- 100,000 650,000 755,000 2,545,000 Ellen E. Chamberlain.... 12,000 12,800 14,400 161,100 110,000 635,200 - --------------- (1) Market value of the Company's Common Stock at the exercise date minus the exercise price. (2) Market value of the Company's Common Stock at fiscal year end minus the exercise price. The fair market value of Seagate Software Common Stock on July 3, 1998, as determined by the Compensation Committee of the Board of Directors, was $12.75 per share. To determine the fair market value of the Company's Common Stock, the Compensation Committee of the Board of Directors considers a number of factors, including, but not limited to, the Company's current financial performance and prospects for future growth and profitability, the status of product releases and product integration, the absence of a resale market for the Company's Common Stock, the liquidity preferences of the Company's Preferred Stock, the control position held by Seagate Technology, and comparisons of certain key valuation metrics for the Company with similar metrics for comparable publicly traded companies, including measures of market capitalization based on revenue multiples, price-to-earnings ratios and operating margins. EMPLOYMENT CONTRACTS, CHANGE-OF-CONTROL ARRANGEMENTS AND SEPARATION AGREEMENTS The Company currently has no employment contracts with any of the Named Officers who are currently employees of the Company, and the Company has no compensatory plan or arrangement with such current Named Officers where the amount to be paid exceeds $100,000 and which are activated upon resignation, termination or retirement of any such Named Officer upon a change in control of the Company. In July 1998, Seagate Technology entered into a Separation Agreement and Release with Alan F. Shugart pursuant to which Mr. Shugart is entitled to receive $2.25 million in compensation (of which none will be paid by the Company) plus certain benefits, the right to certain deferred compensation and the continued vesting and lapse of repurchase rights in shares of the Parent Company's common stock. In addition, options to purchase 88,000 shares of the Company's common stock with exercise prices ranging from $4.00 to $12.75 previously granted to Mr. Shugart by the Company vested in full and will remain exercisable until August 19, 2001. 66 68 DIRECTOR COMPENSATION Directors receive no additional cash compensation for service on the Board of Directors and any of its committees or sub-committees. The following table sets forth certain information concerning grants of stock options to each of the Company's directors during the fiscal year ended July 3, 1998. NUMBER OF EXERCISE OR SECURITIES UNDERLYING BASE PRICE NAME OPTIONS GRANTED(1) PER SHARE(2) ---- --------------------- ------------ Alan F. Shugart(3)............................ 30,000 $ 6.00 15,000 8.75 25,000 12.75 Stephen J. Luczo.............................. 50,000 6.00 50,000 8.75 50,000 12.75 Donald L. Waite............................... -- -- Gary B. Filler................................ 15,000 6.00 Lawrence Perlman.............................. 15,000 6.00 - --------------- (1) All stock options granted in fiscal 1998 vest over four years; 20% at the end of years one and two and 30% at the end of years three and four. Under the Option Plan, the Company's Board retains discretion to modify the terms, including the price, of outstanding options. (2) Options were granted at an exercise price equal to the fair market value of the Company's Common Stock on the grant date, as determined by the Compensation Committee of the Board of Directors of Seagate Software. To determine the fair market value of the Company's Common Stock, the Compensation Committee of the Board of Directors considers a number of factors, including, but not limited to, the Company's current financial performance and prospects for future growth and profitability, the status of product releases and product integration, the absence of a resale market for the Company's Common Stock, the liquidity preferences of the Company's Series A Preferred Stock, the control position held by Seagate Technology, and comparisons of certain key valuation metrics for the Company with similar metrics for comparable publicly traded companies, including measures of market capitalization based on revenue multiples, price-to-earnings ratios and operating margins. (3) Mr. Shugart resigned as a director of the Company effective August 6, 1998 pursuant to the terms of the Separation Agreement and Release between Seagate Technology, Inc. and Mr. Shugart. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934 requires the Company's executive officers and directors and persons who own more than ten percent of a registered class of the Company's equity securities to file reports of ownership and changes in ownership with the Securities and Exchange Commission ("Commission"). Executive officers, directors and greater than ten percent stockholders are required by the Commission's regulation to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it, or written representations from certain reporting persons, the Company believes that with the exception noted below, during the period from December 2, 1997 to July 3, 1998, its executive officers and directors complied with all filing requirements. The Company was delinquent in filing the initial reports on Form 3 by such persons due upon the effectiveness of the Company's Registration Statement on Form 10 but filed such reports later in December 1997. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information regarding the beneficial ownership of the Company's outstanding shares of Common Stock and Series A Preferred Stock on an as-converted basis (collectively with the Common Stock, the "Common Equivalent Shares") as of July 3, 1998 by (i) each person who is known to the Company to be the beneficial owner of 5% or more of the Company's outstanding Common Equivalent Shares, (ii) each of the Company's executive officers named in the Summary Compensation Table at Item 11, 67 69 (iii) each of the Company's directors in office as of July 3, 1998, and (iv) all directors and executive officers as of July 3, 1998 as a group. NUMBER OF COMMON PERCENT OF COMMON EQUIVALENT SHARES EQUIVALENT SHARES(1) ----------------- -------------------- Seagate Technology, Inc.(2)................ 54,695,833 98.4% 920 Disc Drive Scotts Valley, CA 95066 Alan F. Shugart(3)......................... 54,795,833 98.5% Stephen J. Luczo(4)........................ 54,729,833 98.4% Donald L. Waite(5)......................... 54,715,833 98.4% Gary B. Filler(6).......................... 54,706,833 98.4% Lawrence Perlman(7)........................ 54,706,833 98.4% Ellen E. Chamberlain(8).................... 26,400 * Terence R. Cunningham(9)................... 400,000 * Gregory B. Kerfoot(10)..................... 100,000 * All directors and executive officers as a group (8 persons)(11).................... 55,398,233 99.6% - --------------- * Less than one percent. (1) Applicable percentage ownership is based on 55,608,900 Common Equivalent Shares outstanding as of July 3, 1998 together with applicable options for such stockholder. The Company's Series A Preferred Stock is reflected on an as-converted basis assuming a 1:1 conversion. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission based on factors including voting and investment power with respect to shares subject to applicable community property laws. Common Equivalent Shares subject to options currently exercisable or exercisable within 60 days after July 3, 1998 are deemed outstanding for computing the percentage ownership of the person holding such options, but are not deemed outstanding for computing the percentage of any other person. (2) Includes 7,200,000 shares of Class B Exchangeable Shares of Seagate Software Information Management Group (Canada), Inc., Vancouver, British Columbia ("IMG Vancouver"), which may be exchanged at the option of the holder, Seagate Technology International, a subsidiary of the Parent Company, for an equal number of shares of Series A Preferred Stock of the Company within 60 days of July 3, 1998. Excludes 176,000 shares of the Company's Common Stock held by or issuable pursuant to options granted to Messrs. Shugart, Luczo, Waite, Filler and Perlman over which Seagate Technology does not possess sole or shared voting or investment control and therefore of which Seagate Technology disclaims beneficial ownership. (3) Includes 88,000 shares of Common Stock that may be acquired upon the exercise of stock options exercisable within 60 days after July 3, 1998. Includes 54,695,833 shares of Series A Preferred Stock (and 7,200,000 shares of Class B Exchangeable Shares of IMG Vancouver) beneficially owned by Seagate Technology to which Mr. Shugart may be deemed, in his capacity as an officer of Seagate Technology, to have shared power to vote or dispose of. However, Mr. Shugart disclaims such beneficial ownership. Mr. Shugart resigned as a director of the Company effective August 6, 1998. (4) Includes 34,000 shares of Common Stock that may be acquired upon the exercise of stock options exercisable within 60 days after July 3, 1998. Includes 54,695,833 shares of Series A Preferred Stock (and 7,200,000 shares of Class B Exchangeable Shares of IMG Vancouver) beneficially owned by Seagate Technology to which Mr. Luczo may be deemed, in his capacity as an officer of Seagate Technology, to have shared power to vote or dispose of. However, Mr. Luczo disclaims such beneficial ownership. (5) Includes 12,000 shares of Common Stock that are subject to repurchase by the Company. The Company's repurchase right lapses for 6,000 and 6,000 shares on April 4, 1999 and 2000, respectively. Includes 54,695,833 shares of Series A Preferred Stock (and 7,200,000 shares of Class B Exchangeable Shares of IMG Vancouver) beneficially owned by Seagate Technology to which Mr. Waite may be 68 70 deemed, in his capacity as an officer of Seagate Technology, to have shared power to vote or dispose of. However, Mr. Waite disclaims such beneficial ownership. (6) Includes 11,000 shares of Common Stock that may be acquired upon the exercise of stock options exercisable within 60 days after July 3, 1998. Includes 54,695,833 shares of Series A Preferred Stock (and 7,200,000 shares of Class B Exchangeable Shares of IMG Vancouver) beneficially owned by Seagate Technology to which Mr. Filler may be deemed, in his capacity as a director of Seagate Technology, to have shared power to vote or dispose of. However, Mr. Filler disclaims such beneficial ownership. (7) Includes 11,000 shares of Common Stock that may be acquired upon the exercise of stock options exercisable within 60 days after July 3, 1998. Includes 54,695,833 shares of Series A Preferred Stock (and 7,200,000 shares of Class B Exchangeable Shares of IMG Vancouver) beneficially owned by Seagate Technology to which Mr. Perlman may be deemed, in his capacity as a director of Seagate Technology, to have shared power to vote or dispose of. However, Mr. Perlman disclaims such beneficial ownership. (8) Includes 14,400 shares of Common Stock that may be acquired upon the exercise of stock options exercisable within 60 days after July 3, 1998. (9) Includes 260,000 shares of Common Stock that are subject to repurchase by the Company on various dates through 2001. (10) Includes 100,000 shares of Common Stock that may be acquired upon the exercise of stock options exercisable within 60 days after July 3, 1998. (11) Includes 258,400 shares of Common Stock that may be acquired upon the exercise of stock options exercisable within 60 days after July 3, 1998. See notes 2 through 7 to this table regarding reporting of shares held by Seagate Technology. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Pursuant to a General Services Agreement between the Company and Seagate Technology dated June 28, 1997 (the "General Services Agreement"), Seagate Technology provides administrative, accounting and similar services requested by the Company. The services provided by Seagate Technology may include, but are not limited to: (i) providing general accounting services, budgeting, forecasting, cost control and other financial planning services; (ii) assisting with employee benefits administration, hiring and payroll administration; (iii) providing legal and government relations services such as preparing applications for export licenses; (iv) tax analysis, documentation, reporting and withholding for customs duties, import taxes, value-added taxes, and any other charges or taxes imposed on the Company's products; (v) assisting the Company with federal, state, and international tax planning, provisions, audits, and compliance, including income, sales and use, property, VAT, and similar taxes; (vi) providing assistance relating to the marketing, promotion, and sale of the Company's products; (vii) providing services and support relating to information technology and facilities; and (viii) managerial oversight, including screening of potential acquisitions, partnerings, joint ventures, or similar transactions. During 1998, 1997 and 1996 Seagate Technology charged the Company $1,773,000, $1,958,000 and $2,260,000, respectively, for various corporate services. The Company pays service fees to the Parent Company each fiscal year that represent a reasonable estimate of the Parent Company's direct and indirect costs incurred in performing services for the Company. Service fees are to be paid in equal monthly installments within 30 days after the end of the month. Additionally, the Company and Seagate Technology are required to review, on an annual basis, the actual level of services provided and the corresponding reasonably determinable direct and indirect costs incurred by the Parent Company pursuant to the General Services Agreement. If the reasonably determinable costs are greater than or less than the service fees paid, the difference will be charged to or refunded to the Company, as the case may be, within 30 days after such review. The service fees assessed to the Company and the end of period adjustments thereto are intended by the Company and Seagate Technology to allocate costs for those services provided on a basis no less favorable 69 71 than the Company could obtain from an unaffiliated third party. The Company has audit rights with respect to the computation and analysis of service fees pursuant to the General Services Agreement. In addition, the Parent Company is required to indemnify, defend and hold the Company harmless against any and all claims, suits, actions, demands, proceedings, losses, damages, liabilities, costs and expenses, including, without limitation, interest and reasonable attorneys' fees, arising out of, relating to, or resulting from services performed by the Parent Company pursuant to the General Services Agreement, other than those liabilities that would not have arisen but for any act, error and/or omission of the Company and/or any of its officers, directors, employees and/or agents. Additionally, on July 4, 1998, the Company and Seagate Technology renewed the Intercompany Revolving Loan Agreement ("Loan Agreement") on substantially the same terms and conditions as the prior agreement which was dated June 28, 1996. Under the Revolving Loan Agreement, Seagate Technology finances certain of the Company's working capital requirements. The Loan Agreement provides for maximum borrowings of up to $60,000,000 and is renewable every two years. Borrowings from the Parent Company were $16,054,000 and $28,971,000 at July 3, 1998 and June 27, 1997, respectively. Borrowings from the Parent Company consist primarily of funding the Company's operating activities. During 1998, gross borrowings and gross repayments under the Loan Agreement were $175,919,000 and $188,836,000, respectively. Average outstanding borrowings under the Loan Agreement were $14,656,000 during 1998. Beginning in fiscal 1999, the Company will pay interest at the LIBOR rate plus 2% per annum on such borrowings; the Company previously paid interest at 6%. Revenues from the Parent Company were $5,469,000, $5,762,000 and $9,374,000 in fiscal 1998, 1997 and 1996, respectively. This revenue primarily consisted of shipments to Seagate Technology's OEM tape drive divisions located in Costa Mesa, California and Scotland. Additionally, this revenue is supported by license agreements, which have comparable terms and pricing as those agreements between the Company and third party customers. The Company is included in the consolidated federal and certain combined and consolidated foreign and state income tax returns of Seagate Technology. Seagate Technology and the Company have entered into a tax sharing agreement (the "Tax Allocation Agreement") pursuant to which the Company computes hypothetical tax returns as if the Company was not joined in consolidated or combined returns with Seagate Technology. The Company must pay Seagate Technology the positive amount of any such hypothetical taxes. If the hypothetical tax returns show entitlement to refunds, including any refunds attributable to a carryback, then Seagate Technology will pay the Company the amount of such refunds. At year end for both 1998 and 1997, there were no outstanding intercompany tax-related balances between the Company and Seagate Technology. 70 72 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as a part of this Report: 1.Financial Statements. The consolidated financial statements of Seagate Software and subsidiaries and supplemental schedule of the registrant as set forth under Item 8 are filed as part of this Form 10-K/A. 2. Financial Statement Schedules. The following consolidated financial statement schedules of Seagate Software and subsidiaries are filed as part of this Form 10-K/A and should be read in conjunction with the consolidated financial statements of Seagate Software and subsidiaries. DESCRIPTION PAGE ----------- ---- Schedule II -- Valuation and Qualifying Accounts............ 74 Schedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the consolidated financial statements or notes thereto. The independent auditors' report with respect to the above-listed financial statements and schedules appears on page 25 of this report on Form 10-K/A. 3. Exhibits 3.1+ Certificate of Incorporation of Registrant, as amended 3.2+ Bylaws of Registrant, as amended 4.1+ Voting Agreement dated December 26, 1996 among the Registrant, Seagate Software Information Management Group, Inc. and Seagate Technology International Holdings 10.1+ 1996 Stock Option Plan, as amended, form of Stock Option Agreement and form of Amendment to Stock Option Agreement 10.2(A) Seagate Technology, Inc. Employee Stock Purchase Plan, as amended 10.3+ Lease Agreement, dated December 27, 1994, between the Registrant and Clover Investments, Inc. 10.4+ Lease Agreement, dated March 21, 1996 between the Registrant and 400 International Parkway Development Company 10.5*+ General Services Agreement dated June 28, 1997 between the Registrant and Seagate Technology, Inc. 10.6+ Tax Allocation Agreement dated April 4, 1996 between the Registrant and Seagate Technology, Inc. 10.7+ Intercompany Revolving Loan Agreement dated June 28, 1996 between the Registrant and Seagate Technology, Inc. 10.7.1(A) Amendment No. 1 dated July 4, 1998 to Intercompany Revolving Loan Agreement between the Registrant and Seagate Technology, Inc. 10.8+ Form of Indemnification Agreement entered into between the Registrant and its directors and officers 10.9+ Support Agreement dated December 26, 1996 between the Registrant and Seagate Software Information Management Group, Inc. 10.10(A) Lease Agreement dated as of November 1, 1997 by and among Seagate Technology, Inc., Seagate Software Information Management Group, Inc. and No. 163 Cathedral Ventures Ltd. 71 73 10.11(A) Separation Agreement and Release dated July 29, 1998 between Seagate Technology, Inc. and Alan F. Shugart 13.1+ Holistic Systems Ltd. (now Seagate Software Information Management Group Limited) Statements of Consolidated Profits and Cash Flows and Related Notes Year Ended 31 March 1996 21.1(A) Subsidiaries of the Registrant 23.1 Consent of Ernst & Young LLP, Independent Auditors 24.1(A) Power of Attorney 27.1 Amended Financial Data Schedule 27.2 Amended Financial Data Schedule - --------------- * Confidential treatment has been requested for a portion of this exhibit pursuant to a request for confidential treatment filed with the Securities and Exchange Commission. Omitted portions have been filed separately with the Commission. + Incorporated by reference to exhibits filed in response to Item 15(a), "Exhibits" to the Registrant's Registration Statement on Form 10 as filed with the Securities and Exchange Commission on October 3, 1997 as amended on December 11, 1997. (A) Incorporated by reference to exhibits filed in connection with Seagate Technology's Annual Report on Form 10-K for the fiscal year ended July 3, 1998 as filed with the Securities and Exchange Commission on August 21, 1998 (b) Reports on Form 8-K No reports on Form 8-K were filed by the registrant during the quarter ended July 3, 1998. 72 74 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this amended report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. SEAGATE SOFTWARE, INC. By: * ------------------------------------ Terence R. Cunningham President and Chief Operating Officer Dated: April 16, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this amended report on Form 10-K has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. SIGNATURE TITLE DATE --------- ----- ---- * President and Chief April 16, 1999 - ----------------------------------------------------- Operating Officer (Terence R. Cunningham) * Chief Strategic Officer April 16, 1999 - ----------------------------------------------------- (Gregory B. Kerfoot) /s/ ELLEN E. CHAMBERLAIN Senior Vice President, April 16, 1999 - ----------------------------------------------------- Treasurer and Chief (Ellen E. Chamberlain) Financial Officer * Chairman of the Board April 16, 1999 - ----------------------------------------------------- of Directors (Stephen J. Luczo) * Director April 16, 1999 - ----------------------------------------------------- (Gary B. Filler) * Director April 16, 1999 - ----------------------------------------------------- (Lawrence Perlman) * Director April 16, 1999 - ----------------------------------------------------- (Donald L. Waite) *By: /s/ Ellen E. Chamberlain ------------------------------------------------------ Ellen E. Chamberlain Attorney-in-fact 73 75 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS BALANCE AT CHARGED TO BALANCE AT BEGINNING COSTS AND DEDUCTIONS- END OF DESCRIPTION OF PERIOD EXPENSES DESCRIBE(1) PERIOD ----------- ---------- ---------- ----------- ---------- YEAR ENDED JULY 3, 1998: Deducted from asset accounts: Allowance for doubtful accounts............ $1,270,000 $1,177,000 $811,000 $1,636,000 ========== ========== ======== ========== YEAR ENDED JUNE 27, 1997: Deducted from asset accounts: Allowance for doubtful accounts............ $ 597,000 $1,522,000 $849,000 $1,270,000 ========== ========== ======== ========== YEAR ENDED JUNE 28, 1996: Deducted from asset accounts: Allowance for doubtful accounts............ $ 405,000 $ 408,000 $216,000 $ 597,000 ========== ========== ======== ========== - --------------- (1) Uncollectible accounts written off, net of recoveries. 74 76 SEAGATE SOFTWARE, INC. INDEX TO EXHIBITS 3.1+ Certificate of Incorporation of Registrant, as amended 3.2+ Bylaws of Registrant, as amended 4.1+ Voting Agreement dated December 26, 1996 among the Registrant, Seagate Software Information Management Group, Inc. and Seagate Technology International Holdings 10.1+ 1996 Stock Option Plan, as amended, form of Stock Option Agreement and form of Amendment to Stock Option Agreement 10.2(A) Seagate Technology, Inc. Employee Stock Purchase Plan, as amended 10.3+ Lease Agreement, dated December 27, 1994, between the Registrant and Clover Investments, Inc. 10.4+ Lease Agreement, dated March 21, 1996 between the Registrant and 400 International Parkway Development Company 10.5*+ General Services Agreement dated June 28, 1997 between the Registrant and Seagate Technology, Inc. 10.6+ Tax Allocation Agreement dated April 4, 1996 between the Registrant and Seagate Technology, Inc. 10.7+ Intercompany Revolving Loan Agreement dated June 28, 1996 between the Registrant and Seagate Technology, Inc. 10.7.1(A) Amendment No. 1 dated July 4, 1998 to Intercompany Revolving Loan Agreement between the Registrant and Seagate Technology, Inc. 10.8+ Form of Indemnification Agreement entered into between the Registrant and its directors and officers 10.9+ Support Agreement dated December 26, 1996 between the Registrant and Seagate Software Information Management Group, Inc. 10.10(A) Lease Agreement dated as of November 1, 1997 by and among Seagate Technology, Inc., Seagate Software Information Management Group, Inc. and No. 163 Cathedral Ventures Ltd. 10.11(A) Separation Agreement and Release dated July 29, 1998 between Seagate Technology, Inc. and Alan F. Shugart 13.1+ Holistic Systems Ltd. (now Seagate Software Information Management Group Limited) Statements of Consolidated Profits and Cash Flows and Related Notes Year Ended 31 March 1996 21.1(A) Subsidiaries of the Registrant 23.1 Consent of Ernst & Young LLP, Independent Auditors 24.1(A) Power of Attorney 27.1 Amended Financial Data Schedule 27.2 Amended Financial Data Schedule - --------------- * Confidential treatment has been requested for a portion of this exhibit pursuant to a request for confidential treatment filed with the Securities and Exchange Commission. Omitted portions have been filed separately with the Commission. + Incorporated by reference to exhibits filed in response to Item 15(a), "Exhibits" to the Registrant's Registration Statement on Form 10 as filed with the Securities and Exchange Commission on October 3, 1997 as amended on December 11, 1997. (A) Incorporated by reference to exhibits filed in connection with Seagate Technology's Annual Report on Form 10-K for the fiscal year ended July 3, 1998 as filed with the Securities and Exchange Commission on August 21, 1998