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                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                                   FORM 10-K
 
   [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
       EXCHANGE ACT OF 1934
       FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997
 
                                      OR
 
   [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
       EXCHANGE ACT OF 1934
 
                   FOR THE TRANSITION PERIOD FROM        TO
 
                          COMMISSION FILE NO. 1-8465
 
                           STERLING SOFTWARE, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
               DELAWARE                              75-1873956
    (STATE OR OTHER JURISDICTION OF               (I.R.S. EMPLOYER 
    INCORPORATION OR ORGANIZATION)               IDENTIFICATION NO.)
 
                        300 CRESCENT COURT, SUITE 1200
                             DALLAS, TEXAS 75201
         (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
      REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (214) 981-1000
 
         SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
 
          TITLE OF EACH CLASS         NAME OF EACH EXCHANGE ON WHICH REGISTERED
          -------------------         -----------------------------------------
 
     Common Stock, $0.10 Par Value             New York Stock Exchange
 
  Rights to Purchase Series A Junior           New York Stock Exchange
 Participating Preferred Stock, $0.10          
               Par Value
 
         SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
                                     NONE
 
  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 or any
amendment to this Form 10-K. [X]
 
  The aggregate market value of the Registrant's Common Stock held by non-
affiliates of the Registrant was $1,262,736,131, based on the closing sales
price of $34 5/16 of the Registrant's Common Stock on the New York Stock
Exchange on November 10, 1997.
 
  As of November 10, 1997, 38,587,938 shares of the Registrant's Common Stock
were outstanding.
 
                     DOCUMENTS INCORPORATED BY REFERENCE
 
  Portions of the proxy statement for the Annual Meeting of Stockholders of
the Registrant to be held during 1998 are incorporated by reference in Part
III.
 
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                            STERLING SOFTWARE, INC.
 
                               TABLE OF CONTENTS
 
<TABLE>
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 FORM 10-K ITEM                                                            PAGE
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 <C>         <S>                                                           <C>
 PART I.
    Item 1.  Business...................................................     1
    Item 2.  Properties.................................................    12
    Item 3.  Legal Proceedings..........................................    12
    Item 4.  Submission of Matters to a Vote of Security Holders........    12
 PART II.
    Item 5.  Market for Registrant's Common Equity and Related
             Stockholder Matters........................................    13
    Item 6.  Selected Financial Data....................................    14
    Item 7.  Management's Discussion and Analysis of Financial Condition
             and Results of Operations..................................    15
    Item 7A. Quantitative and Qualitative Disclosure About Market Risk..    21
    Item 8.  Financial Statements and Supplementary Data................    22
    Item 9.  Changes in and Disagreements with Accountants on Accounting
             and Financial Disclosure...................................    48
 PART III.
    Item 10. Directors and Executive Officers of the Registrant.........    48
    Item 11. Executive Compensation.....................................    48
    Item 12. Security Ownership of Certain Beneficial Owners and
             Management.................................................    48
    Item 13. Certain Relationships and Related Transactions.............    48
 PART IV.
    Item 14. Exhibits, Financial Statement Schedules and Reports on Form
             8-K........................................................    49
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                                    PART I
 
ITEM 1. BUSINESS.
 
GENERAL
 
  Sterling Software, Inc. ("Sterling Software" or the "Company") was founded
in 198l and became a publicly owned corporation in l983. Sterling Software is
a recognized worldwide supplier of software products and services within three
major markets: systems management, applications management and federal
systems. Consistent with Sterling Software's decentralized operating
structure, major markets are served by independently operated business groups
which consist of divisions and business units that focus on specific business
niches within those markets. See Notes 5 and 6 of Notes to Consolidated
Financial Statements. Sterling Software believes that its decentralized
organizational structure promotes operating flexibility, improves
responsiveness to customer requirements and focuses management on achieving
revenue and operating profit objectives. Sterling Software has historically
expanded its operations through internal growth and by business and product
acquisitions.
 
  In connection with the Company's acquisition of the Software Division of
Texas Instruments Incorporated ("TI Software"), on June 30, 1997, the Company
reorganized into three highly-focused business groups: the Systems Management
Group, the Applications Management Group and the Federal Systems Group. The
reorganization resulted in the Systems Management and Applications Management
groups assuming direct responsibility for the international distribution of
their products. The Company's Federal Systems Group was not significantly
affected by the reorganization.
 
  As of September 30, 1997, the Company's business groups were organized as
follows:
 
  .  The Systems Management Group, headquartered in Plano, Texas, provides
     products that enable customers to ensure the quality of service of
     mission-critical information technology ("IT") applications across
     enterprise networked computing environments. The group specializes in
     automation, network management, service desk, storage management and VM
     systems management products. Linking these products is the group's
     Business-Centric Automation initiative, a pragmatic, business-focused
     approach to ensuring the availability and reliability of these
     applications;
 
  .  The Applications Management Group, headquartered in Plano, Texas,
     provides application development products and services for business
     modeling through code generation, as well as products and services that
     enable customers to extend the life and usefulness of legacy
     applications and to facilitate enterprise information access. These
     software products provide developers the ability to build model-based
     applications through traditional and object-oriented techniques and to
     maximize the life, reuse and value of their legacy systems; and
 
  .  The Federal Systems Group, headquartered in McLean, Virginia, provides
     specialized IT services to the federal government under numerous multi-
     year contracts. Major customers of this group include the U.S.
     Department of Defense ("DoD") and the National Aeronautics and Space
     Administration ("NASA"). Federal Systems' personnel also serve as a
     source of technical expertise for other divisions of Sterling Software
     and provide specialized technical services for non-governmental
     customers.
 
  Worldwide revenue from the Company's Systems Management, Applications
Management and Federal Systems Groups represented 38%, 29% and 25%,
respectively, of the Company's total 1997 revenue. Revenue from the Company's
international operations represented 37% of the Company's 1997 revenue. See
Notes 5 and 6 of Notes to Consolidated Financial Statements.
 
  On September 30, 1996, Sterling Software completed the spin-off of Sterling
Commerce, Inc. ("Sterling Commerce"), which owns and operates the businesses
conducted by Sterling Software's former Electronic Commerce Group. The results
of operations of Sterling Commerce for 1996 and 1995 have been classified as
discontinued operations in the accompanying Consolidated Financial Statements.
Through June 30, 1997, the Company sold, marketed and provided first-level
support outside of the United States and Canada for Sterling
 
                                       1
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Commerce's interchange and communications software products, the results of
which are included in the business segment information presented in the
accompanying Consolidated Financial Statements under "Corporate and other".
See "Shared Management and Other Relationships with Sterling Commerce" below.
 
  A large percentage of Sterling Software's business is recurring business
through annual and multi-year product support agreements, generally having
terms ranging from one to three years, fixed-term product lease and rental
agreements, generally having terms ranging from month-to-month to year-to-
year, and multi-year federal contracts generally having terms ranging from one
to five years. Recurring revenue represented 52% and 54% of the Company's
total revenue in 1997 and 1996, respectively. Sterling Software's customer
base includes approximately 95 of the 100 largest, and approximately 400 of
the 500 largest, U.S. industrial and service corporations, ranked by 1996
revenues as reported in Fortune magazine.
 
  At September 30, 1997, the Company employed approximately 3,100 employees in
85 offices worldwide. The Company has direct sales and marketing offices in 22
countries and distributors and agents in an additional 33 countries.
 
SYSTEMS MANAGEMENT GROUP
 
  Effective June 30, 1997, Sterling Software reorganized the Systems
Management Group by combining the Company's former Systems Management Group
and the related portions of the Company's international operations. The new
Systems Management Group, comprised of five divisions and one business unit,
provides products that enable customers to ensure the quality of service of
mission-critical IT applications across enterprise networked computing
environments. The group specializes in automation, network management, service
desk, storage management and VM systems management products. Linking these
products is the group's Business-Centric Automation initiative, a pragmatic,
business-focused approach to ensuring the availability and reliability of
these applications. The purpose of Business-Centric Automation is to correlate
system and network resources to the business applications that depend on these
functions, and to provide the complete context that IT management personnel
need to match their activities to the priorities of their business. As of
September 30, 1997, the group employed approximately 700 people. Worldwide
revenue from the Systems Management Group represented 38% of the Company's
revenue during 1997 and 39% of the Company's revenue during both 1996 and
1995.
 
  The Operations Management Division provides three product lines under the
SOLVE family name. SOLVE:Netmaster automates network management operations
across large-scale enterprises. This product family provides management and
monitoring of both Systems Network Architecture ("SNA") and Transmission
Control Protocol/Internet Protocol ("TCP/IP") networks from one console. The
SOLVE:Operations product family provides and participates in enterprise-wide
automation solutions, addressing both mainframe (OS/390 and SNA) and
distributed (Simple Network Management Protocol ("SNMP") and non-SNMP) systems
resources. SOLVE:Operations products are available as standalone products
within the OS/390 environment and as plug-in components for three enterprise
management platforms: Hewlett-Packard's "OpenView" and "OpenView
IT/Operations" and Tivoli's "Tivoli/TME 10 NetView". SOLVE:Operations is the
cornerstone of the System Management Group's Business-Centric Automation
initiative. The SOLVE:Operations correlation engine maps system and network
resources to the services or business functions they support and the service-
level requirements and business priorities associated with these services and
functions. This product allows customers to monitor and manage resources as
elements of their service commitment. SOLVE:Central is an integrated suite of
products for running the enterprise IT service desk and is comprised of:
SOLVE:Problem for problem tracking and resolution; SOLVE:Change for managing
the systems change process; SOLVE:Configuration for tracking software and
hardware configuration changes; and SOLVE:Asset for business management of
computer assets and the services they deliver.
 
  The Storage Management Division provides software products under the SAMS
family name. These products manage, monitor and automate data storage in both
distributed and centralized environments. SAMS:Vantage is a client/server
system that provides comprehensive automation, interactive reporting, analysis
 
                                       2
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and predictive modeling capabilities for enterprise-wide storage. SAMS:Vantage
delivers centralized management of distributed storage across OS/390, UNIX,
Windows NT and NetWare environments. The SAMS:Vantage storage management
approach is designed to remain consistent across platforms and to allow
organizations to: manage enterprise data storage in a uniform manner; implement
consistent storage management policies and standards; provide centralized
management of distributed data; and enforce the protection of critical data,
regardless of where it resides. On the OS/390 platform, SAMS:Vantage ties into
the division's data management products providing a comprehensive OS/390
storage management suite. The input/output ("I/O") component of SAMS:Vantage,
the first I/O performance monitor to work across multiple RAID (redundant array
of inexpensive disks) subsystems and DASD (data access storage devices),
analyzes I/O performance and recommends device specific solutions to improve
response times and increase efficiency. The SAMS family of products also
includes SAMS:Disk, a data storage management backup and recovery system;
SAMS:Recover, a disaster recovery product that complements IBM's DFHSM product;
and SAMS:Allocate, a centralized allocation control system. In addition, in
1997, the division introduced SAMS:Vista, a comprehensive tape management
reporting system which enhances tape management systems and assists in the
management of robotic tape systems and high capacity tape devices.
 
  The VM Software Division, through its VM family of products, provides systems
management software and World Wide Web enabling software for IBM's VM/ESA
operating system. The VM:Manager product family provides integrated solutions
for automated operations, storage management, service-level management,
security and disaster recovery and database administration. VM:Manager is
designed to enable VM sites to operate at maximum availability with minimal
systems administration personnel, thereby controlling costs, improving
performance and increasing user productivity. The VM:Webserver product family
enables customers to deliver World Wide Web services from the VM operating
system and to deliver VM applications and data across intranets or the
Internet. VM:Webserver is a World Wide Web server for VM, which allows
customers to exploit user-friendly web browsers to deliver mainframe-based
information to end-users on any platform. VM:Webserver acts as a repository for
home pages and documents created using Hypertext Markup Language ("HTML") and
also stores, retrieves, and processes information in various formats, including
text, graphics, sound, images, video and Java applets. VM:Webserver for
OfficeVision is a turn-key World Wide Web interface to the E-mail and
calendaring features of IBM's OfficeVision/VM, a mainframe-based office
automation solution. VM:Webserver Gateway, released in 1997, provides a
general-purpose, VM-based tool for web-enabling IBM mainframe applications,
including those running on OS/390 (or previous versions of MVS) and VSE/ESA.
 
  The Systems Management Group's new Europe and Asia Pacific Divisions and the
Latin America Operation have responsibility for sales, marketing and first-
level support of the group's products outside of the United States and Canada.
The Europe Division is responsible for direct and indirect sales and support in
Austria, Belgium, Denmark, Finland, France, Germany, Italy, Luxembourg, Norway,
Portugal, Spain, Sweden, Switzerland, The Netherlands and the United Kingdom.
The division's distributor operation manages agents and distributors in
international markets not served by direct operations, including Eastern
Europe, the Middle East and South Africa. The Asia Pacific Division is
responsible for direct and indirect sales and support in Asia and the Pacific
Rim, including Australia, Japan, Malaysia, New Zealand, Singapore and South
Korea. The group's Latin America Operation is responsible for direct sales and
support of the group's products in Brazil and indirect sales and support in
other Latin American markets.
 
APPLICATIONS MANAGEMENT GROUP
 
  Effective June 30, 1997, Sterling Software reorganized the Applications
Management Group by combining the Company's former Applications Management and
Information Management groups, the related portion of the Company's
international operations and the business formerly operated by TI Software. The
new Applications Management Group, comprised of three divisions, provides
application development products and services for business modeling through
code generation, as well as products and services that enable customers to
extend the life and usefulness of legacy applications and to facilitate
enterprise information access. These software products provide developers the
ability to build model-based applications through traditional and object-
oriented techniques and to maximize the life, reuse and value of their legacy
systems. As of September 30, 1997,
 
                                       3
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the group employed approximately 1,100 people. Worldwide revenue from the
Company's Applications Management Group represented 29%, 25% and 27% of the
Company's revenue during 1997, 1996 and 1995, respectively.
 
  The new Applications Development Division markets application development
products and services for business modeling through code generation. Its new
COOL family of products is designed to provide developers the ability to build
model-based applications through traditional and object-oriented techniques.
COOL:Biz is a comprehensive business modeling toolset that promotes an
understanding of organizations and processes with a "common language" for
communicating business needs. The product's methodology for process mapping and
job design allows business and IT professionals to work together to design
business processes. COOL:Dat supports integrated data, data flow and database
modeling. COOL:Dat's conceptual, logical and physical data models are
maintained separately to provide flexibility, but are linked so that changes in
one are reflected in the others, resulting in integrated modeling and
development projects. COOL:Gen is designed to allow developers to model and
generate error free code in a structured, repeatable manner. With COOL:Gen,
high-level specifications are driven forward into dynamic, scalable
applications targeting multiple platforms. COOL:Jex is an object-oriented
analysis and design solution supporting the Unified Modeling Language industry
standard notation and allows modeling of complex application requirements,
driven directly from business requirements. COOL:Cubes, expected to be released
in the first-half of 1998, will represent the latest in component based
development technology and will contain tools for modeling specifications and
architectures, plus component design techniques to maximize reuse of computer
software code.
 
  The Information Management Division markets products and services under the
VISION family name that enable customers to extract value from their existing
corporate data and maximize the return on their IT investment by extending the
life and usefulness of their legacy applications. By improving existing
applications, customers can reconcile their legacy and new development
strategies, conserving resources to permit the implementation of required new
systems. VISION:Results is an information management and report generation
system for IBM enterprise servers and a dynamic complement to COBOL.
VISION:Builder and VISION:Transact are application development tools for batch
and on-line environments, respectively, that operate on major IBM enterprise
server platforms. The VISION:Legacy suite of tools addresses the functions
required to assess the quality and maintainability of applications, restructure
old COBOL programs, redocument the flow of control through legacy systems and
graphically represent the architecture and flow of existing systems. The
VISION:Legacy suite of products, including VISION:Inspect, VISION:Assess,
VISION:Recode and VISION:Redocument, helps address the "Year 2000" effort with
system-wide analysis capabilities and reports to help identify and modify date
and date-related fields. The division also offers consulting services in
conjunction with its software products to provide customized approaches to
address the "Year 2000" issue. In addition, the VISION family of products
includes database query and reporting products that monitor and control
databases. VISION:Clearaccess facilitates end-user access as a query and
reporting tool and VISION:Clearmanage allows database managers to monitor and
control database access in a client/server environment.
 
  The Applications Management Group's new Applications International Division
is responsible for sales, marketing and first-level support of the group's
products outside of the United States and Canada. The division operates through
three regions, representing Central Europe, Western Europe and Asia Pacific, as
well as a distributor operation. The two European regions are responsible for
direct sales and support in Austria, Belgium, France, Germany, Holland, Italy,
Portugal, Spain, Switzerland and the United Kingdom. The Asia Pacific region is
responsible for sales and support in Asia and the Pacific Rim, including
Australia, Japan, Malaysia, New Zealand, Singapore and South Korea. The
distributor operation manages agents and distributors in international markets
not served by direct operations.
 
FEDERAL SYSTEMS GROUP
 
  The Federal Systems Group, comprised of two divisions, provides specialized
IT services to the federal government under numerous multi-year contracts. In
1997, Sterling Software began its 31st year of service to
 
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both NASA and the DoD, the group's major customers. In 1997, the group was
performing work under 142 contracts. Federal Systems' personnel also serve as
a source of technical expertise for other divisions of Sterling Software and
provide specialized technical services for non-governmental customers. As of
September 30, 1997, the group employed approximately 1,200 people. Revenue
from the Federal Systems Group represented 25% of the Company's revenue during
1997 and 26% of the Company's revenue during both 1996 and 1995.
 
  The Information Technology Division provides specialized IT services,
generally requiring top secret security clearances, to military command and
control, intelligence and weather agencies. The division specializes in data
handling, secure communications, networking, systems integration and
application development in support of varied technical projects ranging from
satellite data collection to counter-terrorism. In 1997, the division expanded
its work in weather applications, intelligence applications and command,
control and communications through competitively awarded and follow-on
contracts. The division also increased its commercial work in electronic image
management. The division's computing resources include data processing
facilities approved for classified operations and substantial hardware and
software configurations to support software life cycle activities in a
distributed processing environment.
 
  The Scientific Systems Division is a provider of scientific software support
and specialized IT services to civil sectors of the federal government,
particularly in scientific and engineering areas, and a provider of specialty
software products in advanced visualization and virtual reality. The
division's contracts include projects for spacecraft imagery, supercomputing
outsourcing, systems administration and network security, and applications
such as theoretical and experimental aerodynamics, aerospace testing and
transportation safety. Under contract to NASA, the division's engineers
designed and now operate the NASA Science Internet and developed the
prototypes of new knowledge-based air traffic management software which was
successfully field-tested by the Federal Aviation Administration at airports
in Denver and Dallas/Fort Worth. The division's customers include the Jet
Propulsion Laboratory and the NASA Ames, Lewis and Marshall Centers. In 1997,
the division was a member of the industry team that won the Stratospheric
Observatory for Infrared Astronomy (SOFIA) contract to modify and operate a
Boeing 747-carried infrared telescope to conduct scientific astronomy
missions. In 1997, the division and its staff received various honors and
awards from its customers, including a NASA-Ames Total Quality Management
Incentive Award and the nomination of two of the division's developed
applications for the NASA 1997 Software of the Year Award.
 
SHARED MANAGEMENT AND OTHER RELATIONSHIPS WITH STERLING COMMERCE
 
  The Board of Directors of Sterling Software (the "Board") currently has nine
members. Messrs. Sterling L. Williams, Sam Wyly, Charles J. Wyly, Jr. and Evan
A. Wyly are officers and directors of Sterling Software and are also directors
of Sterling Commerce. In addition, Sterling L. Williams is the Chairman of the
Board of Sterling Commerce and Jeannette P. Meier serves as an Executive Vice
President of both Sterling Software and of Sterling Commerce.
 
  On March 13, 1996, Sterling Commerce completed the initial public offering
(the "Offering") of 13,800,000 shares of its common stock, par value $0.01 per
share ("Commerce Stock"). In anticipation of the Offering, Sterling Software
and Sterling Commerce entered into a number of agreements (the "Intercompany
Agreements") for the purpose of defining certain relationships between them.
As a result of Sterling Software's then ownership interest in Sterling
Commerce, the terms of such Intercompany Agreements were not the result of
arm's length negotiation. The Intercompany Agreements included a tax
allocation agreement, an indemnification agreement and an international
distributor agreement. The tax allocation agreement provides that for periods
during which Sterling Commerce and/or its subsidiaries are included in the
Company's consolidated federal income tax returns or consolidated, combined or
unitary state tax returns, the Company is required to pay to or is entitled to
receive from Sterling Commerce its allocable portion of the consolidated
federal and state income tax liability or refunds, respectively. The
indemnification agreement provides, among other things, that each party
thereto (the "Indemnifying Party") will indemnify the other party thereto and
its directors, officers, employees, agents and representatives (each, an
"Indemnified Party") for liabilities that may be incurred by an
 
                                       5
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Indemnified Party relating to (i) the businesses, operations or assets
conducted or owned or formerly conducted or owned by the Indemnifying Party and
its subsidiaries (except, in the case where the Company is the Indemnifying
Party, the businesses, operations and assets of Sterling Commerce and its
subsidiaries) or (ii) the failure by the Indemnifying Party to comply with any
other agreements executed in connection with the Offering. In addition, the
indemnification agreement provides that Sterling Commerce will indemnify the
Company and its directors, officers, employees, agents and representatives for
any liabilities resulting from or arising out of certain acts, failures to act
or the provision of incorrect factual information by Sterling Commerce in
connection with the Internal Revenue Service ("IRS") ruling request that cause
Sterling Software's pro rata distribution (the "Distribution") of its remaining
ownership interest in Sterling Commerce to be taxable to the Company or its
stockholders. The international distributor agreement (the "International
Distributor Agreement"), which was terminated effective as of June 30, 1997,
defined the terms pursuant to which the Company acted as the exclusive
distributor of certain Sterling Commerce products in markets outside the United
States and Canada. See Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Business Combinations,
Divestitures and Reorganizations--Termination of International Distributor
Agreement" and Note 3 of Notes to Consolidated Financial Statements.
 
  Conflicts of interest may arise between Sterling Software and Sterling
Commerce in a number of areas relating to such ongoing contractual and other
relationships, including potential competitive business activities, tax and
employee benefit matters, indemnity arrangements, and the continued service of
certain directors and executive officers of each of Sterling Software and
Sterling Commerce as directors and executive officers of the other company. The
Board will utilize such procedures in evaluating the terms and provisions of
any material transactions between Sterling Software and Sterling Commerce and
their respective affiliates as the Board may deem appropriate in light of its
fiduciary duties under state law.
 
PRODUCT LICENSES
 
  Sterling Software's products are generally licensed under perpetual use,
fixed-term or usage-based agreements. Sterling Software typically does not sell
or otherwise transfer title to its software products. The Company's license
agreements generally restrict the use of the product to designated sites or
central processing units and prohibit reproduction, transfer or disclosure of
the product; however, some license agreements may cover multiple sites or
multiple central processing units at one site. In 1997, 1996 and 1995, 43%, 44%
and 42%, respectively, of the Company's revenue consisted of products revenue.
 
PRODUCT SUPPORT
 
  Product support is available to Sterling Software customers, typically
through annual contracts generally priced from 12% to 22% of the then current
license fee. Sterling Software's product support contracts allow customers to
receive updated versions of Sterling Software's products when and if they
become available, as well as bug fixing and Internet and telephone access to
Sterling Software's technical personnel. In 1997, 1996, and 1995, 26%, 28% and
29%, respectively, of the Company's revenue consisted of product support
revenue.
 
SERVICES
 
  Services provided by Sterling Software primarily include specialized IT
services in support of federal government contracts provided through the
Company's Federal Systems Group. Sterling Software provides training and
education in support of its software products, in the form of customer training
seminars, videos and instruction materials. Sterling Software also offers
product-specific consulting and education services within the Applications
Management Group to better enable customers to successfully use the group's
products. In 1997, 1996 and 1995, 31%, 28% and 29%, respectively, of the
Company's revenue consisted of services revenue.
 
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PRODUCT DEVELOPMENT
 
  Each domestic division within Sterling Software's Systems Management,
Applications Management and Federal Systems groups has its own development
function. Sterling Software's product development programs in each of these
divisions include the enhancement of existing products and introduction of new
products based upon current and anticipated customer needs. The Company
believes that this organizational structure facilitates development cost
control and focuses the development function on the customer's needs.
Approximately 400 of Sterling Software's employees were engaged in product
development at September 30, 1997. Gross product development costs in 1997,
1996 and 1995 were $42,421,000, $36,448,000 and $39,359,000, respectively, of
which the Company capitalized $19,307,000, $15,527,000 and $11,657,000,
respectively, as the cost of developing and testing new or significantly
enhanced software products.
 
  Most of the products currently offered by the Company are Year 2000
compliant, with the remaining currently offered products expected to become
compliant in 1998 through new releases. See Item 7. "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Other Matters".
 
SALES AND MARKETING
 
  Consistent with its decentralized operating structure, Sterling Software
conducts its sales and marketing activities in multiple software divisions
focused on specific product markets. Sterling Software sells its products and
services through a combination of direct sales and telesales organizations, and
in certain foreign countries, through independent agents and distributors. The
use of telesales has proven effective in reaching customers at a minimal cost.
Each domestic division within the Systems Management and Applications
Management groups has its own United States sales and marketing organization.
In addition, the Systems Management and Applications Management groups have
divisions and business units which focus specifically on the international
marketplace for their respective product lines. Additionally, the Federal
Systems Group has its own sales organization which focuses specifically on
specialized IT service offerings to the federal IT market.
 
CUSTOMERS
 
  Sterling Software's customers include approximately 95 of the 100 largest,
and approximately 400 of the 500 largest, U.S. industrial and service
corporations, ranked by 1996 revenues as reported in Fortune magazine. In the
year ended September 30, 1997, agencies, branches, and departments of the
federal government accounted for approximately 25% of the Company's
consolidated revenue.
 
COMPETITION
 
  The computer software and services industry is highly competitive. Sterling
Software competes with both large companies with substantially greater
resources and small specialized companies that compete in a particular
geographic region or market niche. Sterling Software also competes with
internal programming staffs of corporations and, increasingly, with hardware
manufacturers. Some internal programming staffs of corporations are capable of
developing products similar to those offered by the Company. In general,
however, the Company believes that the time and costs associated with custom
software development significantly exceed the time and costs required to
license and install comparable Sterling Software products. Also, competition
within the Company's federal business is increasing because of continued
federal budget constraints and cutbacks. In addition, continuing consolidation
among providers of technical services to the federal government is increasing
the size and market presence of many of the Company's competitors in this
market segment.
 
  Sterling Software believes that its products will continue to be selected by
customers due to superior product functionality, reliability and technical
support, ease of product installation and use, close integration between the
products and customer business applications and, finally, the Company's history
of success and reputation for providing quality products.
 
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EMPLOYEES
 
  Sterling Software's business is dependent upon its ability to attract and
retain qualified personnel, who are in limited supply. The Company's
operations could be adversely affected if it were to lose the services of a
significant number of qualified employees or if it were unable to obtain
additional qualified employees when needed. The market for highly qualified
personnel in the IT industry is extremely competitive, making it difficult for
companies in this industry, including Sterling Software, to attract and retain
qualified employees. The Company strives to maintain excellent employee
relations, attractive office facilities and challenging working environments,
and offers competitive compensation and benefits packages.
 
  At September 30, 1997, the Company employed approximately 3,100 people.
 
INTELLECTUAL PROPERTY RIGHTS
 
  The Company relies primarily on a combination of copyright, patent and
trademark laws, confidentiality procedures and contractual provisions to
protect its intellectual property rights. The Company routinely enters into
nondisclosure and confidentiality agreements with employees, contractors,
consultants, vendors and customers, and its software licenses generally
prohibit the unauthorized use or disclosure of the Company's proprietary
intellectual property rights. Despite the Company's efforts to protect its
proprietary rights, unauthorized parties may attempt to copy aspects of the
Company's products or to obtain and use information that the Company regards
as proprietary. In addition, the laws of some foreign countries do not protect
the Company's proprietary rights to the same extent as the laws of the United
States. In general, however, management believes that the competitive position
of the Company depends primarily on the skill, knowledge, creativity and
experience of Sterling Software's personnel and their ability to develop,
market and support software products, and that its business is not materially
dependent on copyright protection, trademarks or patents.
 
  The Company does not believe that any of its products infringe on the valid
proprietary rights of third parties in any material respect. However, a large
number of patents, trademarks and copyrights have been, and are being, issued,
registered or asserted in the software industry and there can be no assurance
that the Company is aware of all such intellectual property rights that may
pose a risk of infringement by the Company's products, especially with respect
to United States patents, which can cover extremely broad concepts and the
applications for which are confidential until the patents are issued.
 
  Licenses for a number of software products have been granted to the Company
for its own use or for remarketing to its customers. In the aggregate, these
licenses are significant to the business of the Company, but the Company
believes that the loss of any one of these licenses would not materially
affect the Company's financial position or results of operations.
 
  The COOL, VISION, SAMS, VM and SOLVE families of product names and the marks
"Sterling Software" and "Business-Centric Automation" used herein are
registered or unregistered trademarks owned by the Company.
 
BACKLOG
 
  Sterling Software's backlog relates principally to the uncompleted portion
of multi-year professional services contracts with agencies of the federal
government, including renewal options with government agencies, a portion of
which is restricted by law to a term ending on the last day of the government
agencies' then current fiscal year.
 
  Determination of the Company's backlog involves estimation, particularly
with respect to customer requirements contracts and multi-year contracts of a
cost-reimbursement or incentive nature. A large portion of the Company's
federal government contracts is funded for one year or less and is subject to
contract award, extension or expiration at different times during the year,
and all of the Company's federal government contracts are subject to
termination by the government. Based upon past practices, the Company believes
that the contract
 
                                       8
<PAGE>
 
renewal options included in existing contracts will be exercised for the full
period designated in such contracts, but no assurance can be given that such
contracts will be renewed.
 
  Total backlog, including federal government contract renewal options not yet
exercised and multi-year product support contracts at September 30, 1997 and
1996, was $240,485,000 and $170,912,000, respectively. Of these amounts, 96%
and 97%, respectively, related to federal government sources, primarily in the
Company's Federal Systems Group. The dollar value of federal government
renewal options not yet exercised or funded included in the Company's total
backlog at September 30, 1997 and 1996, was $113,981,000 and $65,951,000,
respectively. Approximately $104,019,000 of the September 30, 1997 backlog is
expected to be realized in the year ending September 30, 1998.
 
EXECUTIVE OFFICERS
 
  The following information regarding the executive and other officers of
Sterling Software is as of November 15, 1997.
 
<TABLE>
<CAPTION>
           NAME           AGE                              POSITION
   ---------------------  --- ------------------------------------------------------------------
   <S>                    <C> <C>
   Sam Wyly                63 Chairman of the Board and Director
   Charles J. Wyly, Jr.    64 Vice Chairman of the Board and Director
   Sterling L. Williams    54 President, Chief Executive Officer and Director
   Geno P. Tolari          54 Executive Vice President and Chief Operating Officer
   Werner L. Frank         68 Executive Vice President
   M. Gene Konopik         54 Executive Vice President and Group President
   Jeannette P. Meier      50 Executive Vice President, Finance and Administration and Secretary
   F.L. "Mike" Harvey      59 Senior Vice President and Group President
   Don J. McDermett, Jr.   39 Senior Vice President and General Counsel
   B. Carole Morton        51 Senior Vice President and Division President
   Gillian M. Parrillo     50 Senior Vice President and Group President
   R. Logan Wray           38 Senior Vice President and Chief Financial Officer
   Ivan S. Hughes(1)       45 Vice President, Organizational Development
   Pamela L. Isbell(1)     38 Vice President, Financial Planning
   Julie Kupp(1)           34 Vice President, Investor Relations
   Evan A. Wyly            35 Vice President and Director
   Laura Appling(1)        35 Controller
   Susan D. Tiholiz(1)     49 Treasurer
</TABLE>
  --------
  (1) Although Ivan S. Hughes, Pamela L. Isbell, Julie Kupp, Laura Appling
      and Susan D. Tiholiz are officers of the Company, the Company does not
      consider such employees to be "executive officers" of the Company, as
      that term is defined in regulations promulgated by the Securities and
      Exchange Commission (the "Commission").
 
  Sam Wyly co-founded Sterling Software in 1981 and since such time has served
as Chairman of the Board and a director. In 1963, Mr. Wyly founded University
Computing Company, a computer software and services company, and served as
President or Chairman from 1963 until 1979. University Computing created a
computer utility network, one of the earliest and most successful marriages of
computing and telecommunications. University Computing was one of the original
participants in the software products industry in the late 1960s when the then
market-dominant IBM unbundled computer hardware and software. In 1968, Mr.
Wyly founded Datran, Inc., which was envisioned as the nation's first all-
digital switched "telephone company for computers" and contributed to the
break up of AT&T's telephone monopoly and the resulting benefits of increased
competition in the telecommunications industry. These Wyly-founded companies
are among the forerunners of today's electronic commerce industry. Mr. Wyly
co-founded Earth Resources Company, an oil refining and silver mining company,
and served as its Executive Committee Chairman from 1968 to 1980. Mr. Wyly and
his brother, Charles J. Wyly, Jr., bought the 20 restaurant Bonanza Steakhouse
chain in 1967. It grew to
 
                                       9
<PAGE>
 
approximately 600 restaurants by 1989, during which time Sam Wyly served as
Chairman. Sam Wyly currently serves as Chairman of Michaels Stores, Inc.
("Michaels Stores"), a specialty retail chain (which has grown from 70 to 525
stores in 13 years of Wyly control), a director of Sterling Commerce, and as a
partner of Maverick Capital, Ltd., an investment fund management company. Sam
Wyly is the father of Evan A. Wyly. Sam Wyly is the Chairman of the Executive
Committee and the 1996 Stock Option Committee of the Board.
 
  Charles J. Wyly, Jr. co-founded Sterling Software in 1981 and since such time
has served as a director, and as Vice Chairman since 1984. He served as an
officer and director of University Computing Company, a computer software and
services company, from 1964 to 1975, including President from 1969 to 1973. Mr.
Wyly and his brother, Sam Wyly, founded Earth Resources Company, an oil
refining and silver mining company, and Charles J. Wyly, Jr. served as Chairman
of the Board from 1968 to 1980. Mr. Wyly served as Vice Chairman of the Bonanza
Steakhouse chain from 1967 to 1989. Mr. Wyly currently serves as Vice Chairman
of Michaels Stores and as a director of Sterling Commerce. Charles J. Wyly, Jr.
is the father-in-law of Donald R. Miller, Jr., a director of the Company. Mr.
Wyly is a member of the Executive Committee and the 1996 Stock Option Committee
of the Board.
 
  Sterling L. Williams co-founded Sterling Software in 1981 and since such time
has served as President, Chief Executive Officer and a director of Sterling
Software. Mr. Williams has served as Chairman of the Board and a director of
Sterling Commerce since December 1995. From December 1995 to October 1996 Mr.
Williams served as Chief Executive Officer of Sterling Commerce. He currently
serves as a director of INPUT, an information technology market research
company. Mr. Williams is a member of the Executive Committee and the 1996 Stock
Option Committee of the Board.
 
  Geno P. Tolari has served as an Executive Vice President of Sterling Software
since March 1990 and as Chief Operating Officer since April 1996. From November
1986 to March 1990 he served as a Senior Vice President of Sterling Software.
Mr. Tolari served as President of the Systems Management Group from December
1994 until February 1997 and as President of the Federal Systems Group from
October 1985 until December 1994.
 
  Werner L. Frank has served as an Executive Vice President of Sterling
Software since April 1996. He served as Executive Vice President, Business
Development from December 1994 to April 1996. From October 1984 until December
1994 Mr. Frank served as an Executive Vice President of Sterling Software. From
July 1993 until December 1994 Mr. Frank served as President of Sterling
Software's former Enterprise Software Group. From 1985 until July 1993 Mr.
Frank served as President of Sterling Software's former Systems Software Group.
 
  M. Gene Konopik has served as an Executive Vice President of Sterling
Software and President of Sterling Software's Federal Systems Group since
December 1994. From July 1993 until December 1994 Mr. Konopik served as the
President of Sterling Software's Information Technology Division. Prior to July
1993 he served as the President of the former Intelligence and Military
Division of Sterling Software.
 
  Jeannette P. Meier has served as Executive Vice President, Finance &
Administration of Sterling Software since May 1997 and as Secretary since 1985.
Prior to May 1997, she served as Executive Vice President (since July 1993), as
Chief Financial Officer (since June 1996) and as General Counsel (since 1985)
of Sterling Software. Prior to July 1993, Ms. Meier served as Senior Vice
President of Sterling Software. Ms. Meier also serves as Executive Vice
President of Sterling Commerce.
 
  F.L. "Mike" Harvey has served as a Senior Vice President of Sterling Software
since June 1997 and as President of the Applications Management Group since
October 1996. From March 1993 through June 1997, he served as President of
Omega Consulting Group Inc., a software consulting company, and from February
1992 to February 1993 he served as Vice President of Restrac Inc., a human
resources software company.
 
  Don J. McDermett, Jr. has served as Senior Vice President and General Counsel
of Sterling Software since May 1997. From July 1996 until May 1997 he served as
Vice President, Legal of Sterling Software. Prior to that
 
                                       10
<PAGE>
 
time Mr. McDermett was employed for 12 years by Thompson & Knight, P.C., a
Dallas-based law firm, having been a senior shareholder in that firm's
corporate practice group since 1993.
 
  B. Carole Morton has served as a Senior Vice President of Sterling Software
and President of Sterling Software's Information Management Division since
October 1995. From October 1996 through June 1997 she also served as President
of the former Information Management Group. Ms. Morton served as President of
Sterling Software's former Applications Engineering Division from December
1994 until October 1995 and President of the former Applications Management
Division from July 1993 through November 1994. Prior to July 1993, she served
as President of the former Dylakor Division.
 
  Gillian M. Parrillo has served as a Senior Vice President of Sterling
Software since February 1997 and as President of Sterling Software's Systems
Management Group since July 1997. Ms. Parrillo served as Group President of
the former International Group from February 1997 until July 1997 and as
President of the Storage Management Division from October 1995 until February
1997. She served as President of the former Distributor Division from July
1993 until September 1995. Prior to July 1993, Ms. Parrillo served as Vice
President of Distributor Operations for Systems Center, Inc.
 
  R. Logan Wray has served as Senior Vice President and Chief Financial
Officer of the Company since May 1997. Prior to that time he was employed by
Ernst & Young LLP, a national accounting firm, having been a partner in that
firm since 1994.
 
  Ivan S. Hughes has served as Vice President, Organizational Development of
the Company since June 1997. Prior to joining the Company he was employed for
19 years by Texas Instruments Incorporated, where he served as Human Resources
Director for TI Software from July 1995 to June 1997 and as Human Resources
Director for the European, Middle Eastern and African operations of TI
Software from June 1992 to July 1995.
 
  Pamela L. Isbell has served as Vice President, Financial Planning of
Sterling Software since April 1996. From April 1988 until April 1996 Ms.
Isbell served as a Financial Analyst of Sterling Software.
 
  Julie G. Kupp has served as Vice President, Investor Relations of Sterling
Software since April 1996. From September 1995 to April 1996 Ms. Kupp served
as Director, Investor Relations and from April 1995 to September 1995 she
served as Senior Financial Analyst of Sterling Software. From December 1993 to
April 1995 Ms. Kupp served as Director of Accounting. Prior to December 1993,
Ms. Kupp was employed by Ernst & Young LLP, a national accounting firm, most
recently as Audit Senior Manager.
 
  Evan A. Wyly has served as a director of Sterling Software since July 1992
and as a Vice President of Sterling Software since December 1994. He has been
a Managing Partner of Maverick Capital, Ltd., an investment fund management
company, since 1991. In 1988, Mr. Wyly founded Premier Partners Incorporated,
a private investment firm, and served as President prior to joining Maverick
Capital, Ltd. Mr. Wyly also serves as a director of Sterling Commerce and as a
director and officer of Michaels Stores, a specialty retail chain.
 
  Laura Appling has served as Controller of Sterling Software since April
1996. From July 1993 to April 1996 Ms. Appling served as Vice President,
Finance for Sterling Commerce's Banking Systems Group. From October 1992 to
July 1993 Ms. Appling served as Senior Financial Analyst for Sterling
Software.
 
  Susan D. Tiholiz has served as Treasurer of the Company since November 1997.
She served as Director of Treasury from June 1996 until November 1997 and as a
consultant to the Company from December 1995 to June 1996. Prior to joining
the Company, Ms. Tiholiz was employed for 17 years by Atlantic Richfield
Company (ARCO), a global energy company, serving in various capacities within
finance, treasury and human resources, most recently as a financial manager in
its domestic natural gas marketing unit.
 
 
                                      11
<PAGE>
 
ITEM 2. PROPERTIES.
 
  With its principal executive office located in Dallas, Texas, the Company
leases offices and facilities in or near more than 70 cities in the United
States and worldwide. Headquarters offices for the Company's groups and
divisions are located in the following cities: Bellevue, Nebraska; London,
England; McLean, Virginia; Paris, France; Plano, Texas; Rancho Cordova,
California; Redwood City, California; Reston, Virginia; Sydney, Australia; and
Woodland Hills, California. Other major United States and international
facilities are located in Amsterdam, The Netherlands; Atlanta, Georgia;
Brussels, Belgium; Dusseldorf, Germany; Herndon, Virginia; Milan, Italy; San
Bernardino, California; Tokyo, Japan and Wiesbaden, Germany.
 
ITEM 3. LEGAL PROCEEDINGS.
 
  On November 30, 1994, Sterling Software acquired KnowledgeWare, Inc.
("KnowledgeWare"), in a stock-for-stock acquisition. On March 14, 1995, the
Commission entered an Order Directing Private Investigation and Designating
Officers to take Testimony titled "In the Matter of KnowledgeWare, Inc. (NY-
6231)". The investigation generally relates to (i) trading in KnowledgeWare
securities from July 1, 1992 through the time of the stock-for-stock
transaction by which Sterling Software acquired KnowledgeWare, (ii)
KnowledgeWare's compliance with its Commission filing and reporting
obligations and (iii) the adequacy and/or accuracy of KnowledgeWare's public
disclosures, recordkeeping and accounting controls. In addition to the
potential liability of the Company's wholly owned subsidiary that was the
surviving corporation in the KnowledgeWare merger, Sterling Software may have
an indemnity obligation with respect to certain individuals who may be subject
to the Commission's investigation. While any legal investigation or proceeding
involves inherent uncertainty, Sterling Software's management believes based
upon presently available information that the ultimate resolution of the
Commission's investigation will not materially affect the financial condition
or results of operations of the Company.
 
  The Company is also subject to certain legal proceedings and claims that
arise in the normal course of its business. In the opinion of management, the
amount of the liability, if any, ultimately incurred by Sterling Software with
respect to any existing proceedings and claims, net of applicable reserves and
available insurance, will not materially affect the financial condition or
results of operations of the Company.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
  The Company did not submit any matters to a vote of security holders during
the fourth quarter of the fiscal year covered by this report.
 
 
                                      12
<PAGE>
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
 
  The Company's common stock, par value $0.10 per share ("Common Stock"), is
traded on the New York Stock Exchange under the symbol "SSW". The high and low
sales prices for the Common Stock for the periods indicated are set forth
below.
 
<TABLE>
<CAPTION>
                                                                  PRICE RANGE
                                                                ---------------
                                                                 HIGH     LOW
                                                                ------- -------
<S>                                                             <C>     <C>
Year Ended September 30, 1997(1):
 Quarter Ended:
  December 31, 1996............................................ $34 5/8 $28 1/4
  March 31, 1997............................................... $32 5/8 $27 1/4
  June 30, 1997................................................ $33 5/8 $27 3/8
  September 30, 1997........................................... $36 3/4 $30 7/8
Year Ended September 30, 1996:
 Quarter Ended:
  December 31, 1995............................................ $62 3/8 $40
  March 31, 1996............................................... $72 5/8 $48 3/4
  June 30, 1996................................................ $81 3/8 $70 3/8
  September 30, 1996........................................... $77 1/2 $62 7/8
</TABLE>
--------
(1) The sales prices for all periods subsequent to September 30, 1996 reflect
    the tax-free Distribution by Sterling Software of all shares of Commerce
    Stock held by Sterling Software to record holders of Common Stock on the
    close of business on that date. Stockholders received 1.59260 shares of
    Commerce Stock for each share of Common Stock owned as of that date.
 
  At November 10, 1997, the Company had approximately 1,022 holders of record
of Common Stock.
 
  With the exception of the tax-free Distribution of shares of Commerce Stock
to the Company's stockholders on September 30, 1996, the Company did not pay
dividends on the Common Stock during the two years ended September 30, 1997 and
does not expect to pay dividends in the foreseeable future.
 
 
                                       13
<PAGE>
 
ITEM 6. SELECTED FINANCIAL DATA.
 
  The following selected financial data should be read in conjunction with the
consolidated financial statements of the Company included elsewhere herein.
 
<TABLE>
<CAPTION>
                                        YEARS ENDED SEPTEMBER 30
                            --------------------------------------------------
                             1997(1)       1996    1995(2)     1994   1993(3)
                            ----------  ---------- --------  -------- --------
                              (IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
<S>                         <C>         <C>        <C>       <C>      <C>
Operating data:
  Revenue.................. $  488,978  $  439,171 $396,311  $325,903 $303,207
  Cost of sales............    199,806     182,239  160,735   143,889  149,454
  Product development and
   enhancement.............     23,114      20,921   27,702    20,505   20,919
  Selling, general and
   administrative..........    197,341     175,237  147,552   112,380  115,403
  Income from continuing
   operations before
   reorganization costs,
   purchased research and
   development, other
   income (expense), income
   taxes, extraordinary
   item and cumulative
   effect of a change in
   accounting principle....     68,717      60,774   60,322    49,129   17,431
  Reorganization costs.....    106,037               19,512             87,622
  Purchased research and
   development.............    137,849               62,000
  Income (loss) from
   continuing operations
   before income taxes,
   extraordinary item and
   cumulative effect of a
   change in accounting
   principle...............   (136,396)     84,886  (18,656)   46,346  (73,153)
  Income (loss) from
   continuing operations
   before extraordinary
   item and cumulative
   effect of a change in
   accounting principle....   (132,968)     60,598  (33,656)   30,586  (48,041)
  Income from discontinued
   operations, net of
   taxes...................                 51,187   42,930    27,753   15,194
  Gain on the initial
   public offering of
   subsidiary, net of
   taxes...................                126,103
  Income (loss) applicable
   to common stockholders..   (132,968)    237,888    9,129    58,143  (38,106)
  Average common shares
   outstanding.............     38,494      32,316   23,649    19,812   17,507
Per common share data:
  Income (loss) from
   continuing operations
   before extraordinary
   item and cumulative
   effect of a change in
   accounting principle:
    Primary................      (3.45)       1.78    (1.43)     1.33    (2.80)
    Fully diluted..........      (3.45)       1.73    (1.43)     1.29    (2.80)
  Income (loss) before
   extraordinary item and
   cumulative effect of a
   change in accounting
   principle:
    Primary................      (3.45)       6.98      .39      2.54    (1.93)
    Fully diluted..........      (3.45)       6.65      .39      2.31    (1.93)
  Net income (loss):
    Primary................      (3.45)       6.98      .39      2.54    (2.18)
    Fully diluted..........      (3.45)       6.65      .39      2.31    (2.18)
Balance sheet data:
  Working capital.......... $  558,746  $  732,918 $218,713  $122,961 $ 57,106
  Total assets.............  1,065,658   1,097,613  657,711   444,661  364,087
  Long-term debt...........                         116,668   115,932  117,532
  Other noncurrent liabili-
   ties....................     49,249      36,397   21,845    18,867   18,331
  Stockholders' equity.....    748,254     879,491  348,338   175,804   97,697
</TABLE>
 
                                       14
<PAGE>
 
--------
(1) On June 30, 1997, Sterling Software completed the acquisition of TI
    Software for approximately $214,774,000 including costs directly related
    to the acquisition. The acquisition was accounted for in accordance with
    the purchase method of accounting and, accordingly, the results of
    operations of TI Software are included in the Company's results of
    operations from the date of acquisition. The 1997 results of operations
    include $137,849,000 of purchased research and development costs, which is
    the portion of the purchase price attributable to in-process research and
    development and which was charged to expense in accordance with the
    purchase method of accounting. The 1997 results of operations also include
    reorganization costs of $106,037,000 primarily related to the
    reorganization of the Company's operations in connection with the
    acquisition of TI Software and the termination of the Company's
    International Distributor Agreement with Sterling Commerce. These
    reorganization costs also include the write-down of certain excess cost
    over net assets acquired related to the Company's federal systems
    business. The tax benefit related to the purchased research and
    development and reorganization costs was $39,737,000. See Item. 7
    "Management's Discussion and Analysis of Financial Condition and Results
    of Operations--Business Combinations, Divestitures and Reorganizations"
    and Notes 2 and 3 of Notes to Consolidated Financial Statements.
 
(2) The 1995 results of operations include $62,000,000 of purchased research
    and development costs charged to expense in accordance with the purchase
    method of accounting in connection with the merger of the Company with
    KnowledgeWare, as well as $19,512,000 of reorganization costs primarily
    related to the reorganization of the Company's operations in connection
    with the merger. See Note 2 of Notes to Consolidated Financial Statements.
 
(3) The 1993 results of operations include $87,622,000 of reorganization costs
    primarily related to the reorganization of the Company's operations in
    connection with the combination of Sterling Software and Systems Center,
    Inc.
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
 
BUSINESS COMBINATIONS, DIVESTITURES AND REORGANIZATIONS
 
  Acquisition of TI Software
 
  On June 30, 1997, Sterling Software completed the acquisition (the
"Acquisition") of certain assets (including the capital stock of certain
foreign subsidiaries) of Texas Instruments Incorporated ("Texas Instruments").
Such assets constitute substantially all of the assets used by TI Software in
its business of developing, marketing, licensing, supporting and maintaining
application development software and providing related consulting services.
The results of operations of TI Software are included in the Company's results
of operations from the date of the Acquisition.
 
  The cash purchase price paid for such assets was $165,000,000 and was funded
from the Company's available cash balances. The total cost of the Acquisition
was approximately $214,774,000, including costs directly related to the
Acquisition of approximately $49,774,000, consisting of employee termination
costs, transaction costs, costs associated with the elimination of duplicate
facilities and other direct costs. Results of operations for 1997 include
$137,849,000 of purchased research and development costs, which is the portion
of the purchase price attributed to in-process research and development, and
which was charged to expense in accordance with the purchase method of
accounting.
 
  Termination of International Distributor Agreement
 
  Sterling Commerce, formerly a wholly owned subsidiary of Sterling Software
formed to operate the business of Sterling Software's former Electronic
Commerce Group, completed the Offering of 13,800,000 shares of Commerce Stock
on March 13, 1996. In anticipation of the Offering, Sterling Software and
Sterling Commerce entered into the International Distributor Agreement
pursuant to which Sterling Software acted as the exclusive distributor of
certain Sterling Commerce products in markets outside the United States and
Canada. Effective as
 
                                      15
<PAGE>
 
of June 30, 1997, Sterling Software and Sterling Commerce entered into an
agreement terminating the International Distributor Agreement.
Contemporaneously with such termination, Sterling Software sold to Sterling
Commerce certain of the assets formerly used by Sterling Software in
connection with the distribution of certain Sterling Commerce products outside
the United States and Canada. In addition, Sterling Software and Sterling
Commerce entered into certain short-term transitional arrangements relating to
facilities sharing and administrative and other services.
 
  In consideration of the termination of the International Distributor
Agreement and the sale of assets described above, Sterling Commerce (i) paid
to Sterling Software $5,226,000 on June 30, 1997, (ii) subsequently paid to
Sterling Software $10,076,000, which was equal to the net book value of the
acquired assets and (iii) assumed certain liabilities of Sterling Software.
 
  Reorganization Costs
 
  The Company's results of operations for 1997 include reorganization costs of
$106,037,000 primarily related to the reorganization of the Company's
operations in connection with the Acquisition and the termination of the
Company's International Distributor Agreement with Sterling Commerce. These
reorganization costs also include the write-down of certain excess cost over
net assets acquired related to the Company's federal systems business.
 
  Of the total reorganization costs, approximately $63,726,000 is a non-cash
cost and the remaining $42,311,000 requires cash outlays. Currently, the
Company does not expect to incur costs related to this reorganization in
excess of the amount charged to operations in 1997.
 
SUBSIDIARY INITIAL PUBLIC OFFERING AND SPIN-OFF
 
  Sterling Commerce completed the Offering of 13,800,000 shares of Commerce
Stock on March 13, 1996. Pursuant to the Offering, Sterling Software sold to
the public 12,000,000 of its 73,200,000 shares of Commerce Stock and Sterling
Commerce sold 1,800,000 of previously unissued shares of Commerce Stock. The
Offering price was $24 per share of Commerce Stock, resulting in net proceeds
to Sterling Software of approximately $265,458,000 after deducting
underwriting discounts and commissions and Sterling Software's pro rata share
of Offering expenses. Sterling Software recorded a gain of approximately
$126,103,000, net of tax, from the sale of Commerce Stock in the Offering.
 
  On September 30, 1996, Sterling Software completed the spin-off of Sterling
Commerce with the pro rata Distribution of its remaining 81.6% ownership in
Sterling Commerce to Sterling Software's stockholders by means of a tax-free
dividend. Holders of record of Common Stock as of the close of business on
September 30, 1996 received 1.59260 shares of Commerce Stock for each share of
Common Stock owned on such date. The Distribution resulted in the reduction of
Sterling Software's stockholders' equity in the amount of $113,549,000,
representing the book value of net assets distributed.
 
RESULTS OF OPERATIONS
 
  The results of operations of Sterling Commerce for 1996 and 1995 have been
classified as discontinued operations in the accompanying Consolidated
Financial Statements.
 
  1997 Compared to 1996
 
  Total revenue increased $49,807,000, or 11%, in 1997 over 1996 due to
increases in all three of the Company's business segments. Total revenue
generated from Sterling Software's international operations was $179,880,000
and $167,845,000 in 1997 and 1996, respectively, representing an increase of
$12,035,000, or 7%, primarily due to increases in the systems management
business segment (up 4%) and in the applications management business segment
(up 35%). The significant increase in international revenue from the
applications management business segment is primarily attributable to revenue
from the new Applications International
 
                                      16
<PAGE>
 
Division, which includes the international operations that were acquired in
the Acquisition. The increase in international revenue from Sterling
Software's products and services was partially offset by a decline in revenue
from sales of Sterling Commerce's interchange and communications software
products and services due to the termination of the International Distributor
Agreement during 1997. In addition, international operating results were
adversely impacted by foreign currency exchange rate fluctuations in 1997, as
a result of a stronger U.S. dollar. Had foreign currency exchange rates
remained consistent with the previous year, international revenue would have
been higher in 1997 by approximately $11,000,000. Revenue from the Company's
international operations represented 37% of total revenue for 1997 and 38% for
1996. The Company currently expects revenue from its international operations
to constitute a larger percentage of the Company's total revenue in future
reporting periods.
 
  The Company's recurring revenue includes revenue from product support
agreements generally having terms ranging from one to three years, fixed-term
product lease and rental agreements generally having terms ranging from month-
to-month to year-to-year, and federal contracts generally having terms ranging
from one to five years. Like most federal contracts, Sterling Software's
federal contracts permit termination by the government for convenience or for
failure to obtain funding. Recurring revenue represented 52% of total revenue
in 1997 compared to 54% in the 1996.
 
  Revenue from the systems management business segment increased $13,875,000,
or 8%, in 1997 over 1996 primarily due to an increase of 15% in products
revenue partially offset by a slight decline in product support revenue. The
increase in products revenue was mainly attributable to strong domestic and
international product sales in the operations management and storage
management product lines. Approximately 49% of the systems management business
segment's 1997 revenue was derived from the Company's international
operations, compared to 51% in 1996.
 
  Revenue from the applications management business segment increased
$33,138,000, or 30% in 1997 over 1996 due to a 20% increase in products
revenue, a 13% increase in product support revenue and a 161% increase in
services revenue. The significant increase in revenue from the applications
management business segment is primarily attributable to revenue from the new
Applications Development and Applications International divisions, which
include the domestic and international operations that were acquired in the
Acquisition. Approximately 37% of the applications management business
segment's 1997 revenue was derived from the Company's international
operations, compared to 35% in 1996.
 
  Revenue from the federal systems business segment increased $9,602,000 or
9%, due to higher contract billings in both the Information Technology
Division and the Scientific Systems Division and due to a contract with the
intelligence community added to the Company's federal systems business segment
as a result of the Acquisition. In June 1997, NASA announced that the
Scientific Systems Division was not selected for continuation of a contract
with NASA's Ames Research Center for Federal Information Processing Services;
however, the selection of another bidder was later rescinded. Although the
final outcome of this procurement remains uncertain, the Company continues to
perform services for NASA's Ames Research Center under an extension of the
existing contract.
 
  Total costs and expenses increased $285,750,000 in 1997 compared to 1996.
Excluding the Acquisition-related reorganization costs of $106,037,000 and the
write-off of purchased research and development costs of $137,849,000 in 1997,
total costs and expenses increased $41,864,000, or 11%, in 1997 compared to
1996.
 
  Total cost of sales increased $17,567,000, or 10%, in 1997 compared to 1996,
commensurate with the increase in revenue. Cost of sales represented 41% of
revenue in 1997 and 1996.
 
  Product development expense for 1997 was $23,114,000, net of $19,307,000 of
capitalized software costs, as compared with 1996 product development expense
of $20,921,000, net of $15,527,000 of capitalized software costs. Gross
product development expense was 12% of non-federal revenue in 1997 compared
with 11% in 1996. Capitalized development costs represented 46% and 43% of
gross development costs in 1997 and 1996,
 
                                      17
<PAGE>
 
respectively. Product development expenses and the capitalization rate
historically have fluctuated, and may in the future continue to fluctuate,
from period to period depending in part upon the number and status of software
development projects which are in process.
 
  Selling, general and administrative expense increased $22,104,000, or 13%,
in 1997 compared to 1996 and represented 40% of revenue in both 1997 and 1996.
 
  Interest expense decreased $2,821,000 in 1997 compared to 1996 due to the
redemption in 1996 of the Company's 5.75% Convertible Subordinated Debentures
(the "Debentures"). See Note 10 of Notes to Consolidated Financial Statements.
Investment income increased $12,048,000 in 1997 over 1996 as a result of
higher average cash and cash equivalents and marketable securities balances.
 
  The Company's loss from continuing operations before taxes was $136,396,000
in 1997 as compared to income from continuing operations before taxes of
$84,886,000 in 1996. Excluding the $137,849,000 charge for purchased research
and development and the $106,037,000 of reorganization costs, income from
continuing operations before taxes increased $22,604,000, or 27%, in 1997
compared to 1996 primarily due to higher operating profits in all three of the
Company's business segments and increases in investment income.
 
  The Company's effective tax rate for the year ended September 30, 1997 was
34% before the net tax benefit related to the reorganization costs and
purchased research and development costs, as described above, compared to an
effective tax rate of 29% for 1996. The effective tax rate benefit for the
year ended September 30, 1997 of 3% significantly varies from the U.S.
statutory rate due primarily to technology acquired in jurisdictions with a
statutory rate below the U.S. rate and the write-down of excess cost over net
assets acquired recorded in connection with previous acquisitions.
 
  Income from discontinued operations, net, for 1996 represents the
classification of the results of operations of Sterling Commerce as
discontinued. See Note 3 of Notes to Consolidated Financial Statements.
 
  1996 Compared to 1995
 
  Total revenue increased $42,860,000, or 11%, in 1996 over 1995 due to
increases in all three of the Company's business segments as well as increases
in sales of certain electronic commerce products internationally. See
"Business Combinations, Divestitures and Reorganizations--Termination of
International Distributor Agreement". Total revenue generated from Sterling
Software's international operations was $167,845,000 in 1996 and $152,026,000
in 1995, representing an increase of $15,819,000, or 10%, over 1995. Had
foreign currency exchange rates remained consistent with the previous year,
international revenue would have been higher in 1996 by approximately
$2,000,000. Revenue from the Company's international operations represented
38% of total revenue in both 1996 and 1995. The Company's recurring revenue,
as described above, represented 54% of total revenue in 1996 compared to 55%
of total revenue in 1995.
 
  Revenue from the systems management business segment increased $16,147,000,
or 10%, in 1996 over 1995 primarily due to an increase of 16% in products
revenue. Products revenue increased across all product lines. Product support
revenue increased 1% primarily due to increases in the storage management and
operations management product lines partially offset by declines in the VM
product line due to the continuing trend of consolidation and downsizing by
customers using the VM operating system. Approximately 51% of the systems
management business segment's 1996 revenue was derived from the Company's
international operations, compared to 54% in 1995.
 
  Revenue from the applications management business segment increased
$2,595,000, or 2%, in 1996 over 1995 primarily due to an increase in products
revenue in the information management product line partially offset by
products and product support revenue declines of approximately $9,200,000
related to products no longer actively marketed and product marketing rights
no longer owned in 1996 versus 1995. In addition, the applications management
business segment revenue increase was partially offset by decreases in
products and product support revenue in the application development product
line and by a decline in consulting services
 
                                      18
<PAGE>
 
revenue due to the elimination of the Consulting Services Division during
1996. Approximately 35% of the applications management business segment's 1996
revenue was derived from the Company's international operations, compared to
39% in 1995.
 
  Federal systems revenue increased $10,486,000, or 10%, in 1996 over 1995
primarily due to higher contract billings in the Information Technology
Division, offset in part by lower contract billings in the Scientific Systems
Division due to the completion of certain contracts at NASA.
 
  Total costs and expenses decreased $39,104,000, or 9%, in 1996 compared to
1995. Excluding the reorganization costs of $19,512,000 and purchased research
and development costs of $62,000,000, in connection with the merger of the
Company with KnowledgeWare in 1995, total costs and expenses increased
$42,408,000, or 13%, in 1996 over 1995.
 
  Total cost of sales increased $21,504,000, or 13%, in 1996 compared to 1995,
commensurate with the increase in total revenue. Cost of sales represented 41%
of revenue in both 1996 and 1995.
 
  Product development expense for 1996 of $20,921,000, net of $15,527,000 of
capitalized software costs, decreased $6,781,000 from 1995 primarily due to a
reduction of gross development costs in the applications management business
segment. Capitalized development costs represented 43% and 30% of gross
development costs for 1996 and 1995, respectively. The higher capitalization
rate is due to a greater number of development projects having reached
technological feasibility in 1996 compared to 1995. Product development
expenses and the capitalization rate historically have fluctuated, and may in
the future continue to fluctuate, from period to period depending in part upon
the number and status of software development projects which are in process.
 
  Selling, general and administrative expense increased $27,685,000, or 19%,
in 1996 over 1995 primarily due to increased sales, marketing and customer
support activities supporting revenue growth in the Company's international
operations offset by declines in the applications management business segment.
 
  Interest expense decreased $5,221,000 in 1996 compared to 1995 primarily due
to the redemption in 1996 of the Debentures. See Note 10 of Notes to
Consolidated Financial Statements. Investment income in 1996 increased
$17,857,000 over 1995 as a result of higher average cash and cash equivalents
and marketable securities balances primarily resulting from the net proceeds
from the Offering of approximately $265,458,000 and the proceeds from the
exercise of stock options and warrants of approximately $276,637,000.
 
  Income from continuing operations before income taxes in 1996 was
$84,886,000 compared to a loss from continuing operations before income taxes
in 1995 of $18,656,000. The loss from continuing operations before income
taxes in 1995 is due to reorganization costs of $19,512,000 and $62,000,000 of
purchased research and development costs related to the merger with
KnowledgeWare and expensed in accordance with the purchase method of
accounting. Excluding the reorganization costs and the write-off of purchased
research and development costs in 1995, income from continuing operations
before income taxes increased $22,030,000, or 35%, over 1995, primarily due to
higher profits in the systems management and federal systems business segments
partially offset by lower profits in the applications management business
segment and losses from the sale of certain electronic commerce products
internationally.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  The Company maintained a strong liquidity and financial position with
$558,746,000 of working capital at September 30, 1997, which includes
$435,726,000 of cash and equivalents and $206,965,000 of marketable
securities. For the year, net cash flows from operations were $124,703,000.
Cash flows from operations, together with other available cash, were used to
fund the Acquisition and related costs and to fund additions to property and
equipment and capitalized software.
 
  The total cost of the Acquisition was approximately $214,774,000, including
costs directly related to the Acquisition of approximately $49,774,000. The
Company's 1997 results of operations include reorganization costs of
$106,037,000 primarily related to the reorganization of the Company's
operations in connection with
 
                                      19
<PAGE>
 
the Acquisition and the termination of the International Distributor Agreement
with Sterling Commerce. Of the total reorganization costs, approximately
$63,726,000 consisted of non-cash costs and the remaining $42,311,000 required
cash outlays. Of the aggregate $92,085,000 of costs directly related to the
Acquisition and reorganization costs requiring cash outlays, approximately
$40,539,000 had been paid at September 30, 1997.
 
  Capitalized software expenditures in 1997 were $19,418,000, primarily for
the development of the Company's products and enhancements, compared to
$15,852,000 in 1996.
 
  Effective July 1, 1997, the Company entered into an amended Revolving Credit
Agreement ("Credit Agreement") with an unsecured borrowing capacity of
$35,000,000. The Credit Agreement requires that certain financial ratios be
maintained. Borrowings under the Credit Agreement will bear interest at the
lower of the lender's base rate or the Eurodollar lending rate plus one-half
percent and will mature on June 30, 2000. No amounts were borrowed during 1997
or outstanding under the Credit Agreement at September 30, 1997. At September
30, 1997, after the utilization of approximately $1,443,000 for standby
letters of credit, approximately $33,557,000 was available for borrowing under
the Credit Agreement. Certain of the Company's foreign subsidiaries have
separate lines of credit totaling $21,305,000 that are used for foreign
exchange exposure management and working capital requirements. These lines of
credit are guaranteed by Sterling Software, Inc. At September 30, 1997,
$1,081,000 was outstanding pursuant to these foreign lines of credit.
 
  During 1996, Sterling Software received proceeds of approximately
$276,637,000 from the exercise of approximately 9,222,000 employee stock
options and warrants. Also in 1996, the Company sold to the public 12,000,000
of its 73,200,000 shares of Commerce Stock resulting in net proceeds to the
Company of approximately $265,458,000, after deducting underwriting discounts
and commissions and the Company's pro rata share of Offering expenses.
 
  On December 20, 1995, the Company gave notice of the redemption of all of
the $114,922,000 then outstanding principal amount of the Debentures,
effective February 12, 1996. Approximately $114,912,000 principal amount of
the Debentures were converted into 4,056,000 shares of Common Stock.
 
  On October 2, 1995, the Company renewed a share repurchase program
authorizing the repurchase of shares of its Common Stock from time to time
through open-market transactions. From October 2, 1995 to March 31, 1996,
approximately 1,336,000 shares of Common Stock were repurchased under the
program for an aggregate purchase price of approximately $59,372,000. No
shares of Common Stock have been repurchased subsequent to March 31, 1996, and
it is the Company's present intention not to resume the repurchase of Common
Stock.
 
  At September 30, 1997, the Company's existing capital commitments consisted
primarily of commitments under lease arrangements for office space and
equipment. The Company intends to meet such obligations primarily from cash
flow from operations. The Company believes available cash balances, cash
equivalents and short-term investments combined with cash flows from
operations and amounts available under existing credit agreements are
sufficient to meet the Company's cash requirements for the foreseeable future.
 
OTHER MATTERS
 
  Demand for many of the Company's products tends to increase with increases
in the rate of inflation as customers strive to improve employee productivity
and reduce costs. However, the effect of inflation on the Company's relatively
labor intensive cost structure could adversely affect its results of
operations to the extent the Company is unable to recover increased operating
costs through increased prices for, or increased sales of, its products and
services.
 
  The assets and liabilities of the Company's non-U.S. operations are
translated into U.S. dollars at exchange rates in effect as of the respective
balance sheet dates, and revenue and expense accounts of these operations are
translated at average exchange rates during the month the transactions occur.
Unrealized translation gains and losses are included as an adjustment to
retained earnings. The Company has mitigated a portion of its currency
 
                                      20
<PAGE>
 
exposure through decentralized sales, marketing and support operations and
through international development facilities, in which substantially all costs
are local-currency based. In the past, the Company has entered, and may in the
future enter into, hedging transactions in an effort to reduce its exposure to
currency exchange risks.
 
  The Company maintains a strategy of seeking to acquire businesses and
products to fill strategic market niches. This acquisition strategy has
contributed in part to the Company's growth in revenue and operating profit
before reorganization and purchased research and development costs. The impact
of future acquisitions on continued growth in revenue and operating profit
cannot presently be determined.
 
  As widely reported, all users of IT systems are contending with the "Year
2000" compliance issue, i.e., the issue of whether those systems are capable
of processing without error or interruption date-related data from more than
one century. The Company does not expect to incur significant expense in
ensuring that its internal IT systems are Year 2000 compliant, nor does it
anticipate any significant difficulties in attaining such compliance. In
addition, most of the products currently offered by the Company are Year 2000
compliant, with the remaining currently offered products expected to become
compliant in 1998 through new releases. Because Year 2000 compliance is
integrated into its normal product development activities, the Company does
not expect to incur any significant incremental expense in addressing the Year
2000 compliance issue in its products. The Company's products operate on and
in IT systems consisting of third party hardware and software, some of which
may not be fully Year 2000 compliant. Regardless of whether the Company's
products are Year 2000 compliant, there can be no assurance that customers
will not assert Year 2000 related claims against the Company.
 
FORWARD-LOOKING INFORMATION
 
  This report and other reports and statements filed by the Company from time
to time with the Securities and Exchange Commission (collectively, "SEC
Filings") contain, or may contain, certain forward-looking statements and
information that are based on the beliefs of, and information currently
available to, the Company's management, as well as estimates and assumptions
made by the Company's management. When used in SEC Filings, words such as
"anticipate," "believe," "estimate," "expect," "future," "intend," "plan" and
similar expressions, as they relate to Sterling Software or Sterling
Software's management, identify forward-looking statements. Such statements
reflect the current views of Sterling Software with respect to future events
and are subject to certain risks, uncertainties and assumptions relating to
Sterling Software's operations and results of operations, competitive factors
and pricing pressures, shifts in market demand, the performance and needs of
the industries served by Sterling Software, the costs of product development
and other risks and uncertainties, including, in addition to any uncertainties
specifically identified in the text surrounding such statements, uncertainties
with respect to changes or developments in social, economic, business,
industry, market, legal and regulatory circumstances and conditions and
actions taken or omitted to be taken by third parties, including the Company's
stockholders, customers, suppliers, business partners, competitors, and
legislative, regulatory, judicial and other governmental authorities and
officials. Should one or more of these risks or uncertainties materialize, or
should the underlying estimates or assumptions prove incorrect, actual results
or outcomes may vary significantly from those anticipated, believed,
estimated, expected, intended or planned.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
 
  Not required.
 
                                      21
<PAGE>
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
                            STERLING SOFTWARE, INC.
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           ----
<S>                                                                        <C>
Report of Independent Auditors............................................  23
Consolidated Financial Statements:
  Consolidated Balance Sheets as of September 30, 1997 and 1996...........  24
  Consolidated Statements of Operations for the Years Ended September 30,
   1997, 1996 and 1995....................................................  25
  Consolidated Statements of Stockholders' Equity for the Years Ended
   September 30, 1997, 1996 and 1995......................................  26
  Consolidated Statements of Cash Flows for the Years Ended September 30,
   1997, 1996 and 1995....................................................  27
  Notes to Consolidated Financial Statements..............................  28
</TABLE>
 
                                       22
<PAGE>
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors and Stockholders
Sterling Software, Inc.
 
  We have audited the accompanying consolidated balance sheets of Sterling
Software, Inc. (the "Company") as of September 30, 1997 and 1996, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended September 30, 1997. Our
audits also included the financial statement schedule listed under Item 14(a)
of the Company's Annual Report on Form 10-K for the year ended September 30,
1997. These 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 audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
 
  In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of the Company at
September 30, 1997 and 1996, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended September 30,
1997 in conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
 
                                          /s/ Ernst & Young LLP
 
Dallas, Texas
November 7, 1997
 
                                       23
<PAGE>
 
                            STERLING SOFTWARE, INC.
                          CONSOLIDATED BALANCE SHEETS
                          SEPTEMBER 30, 1997 AND 1996
                    (IN THOUSANDS, EXCEPT SHARE INFORMATION)
 
<TABLE>
<CAPTION>
                                                          1997        1996
                                                       ----------  ----------
<S>                                                    <C>         <C>
                        ASSETS
Current assets:
  Cash and cash equivalents........................... $  435,726  $  524,237
  Marketable securities...............................    206,965     231,919
  Accounts and notes receivable, net..................    149,422     133,383
  Income tax receivable...............................      9,941       8,000
  Prepaid expenses and other current assets...........     24,847      17,104
                                                       ----------  ----------
    Total current assets..............................    826,901     914,643
Property and equipment, net...........................     48,598      39,330
Computer software, net of accumulated amortization of
 $87,258 in 1997 and $84,099 in 1996..................     70,422      57,488
Excess cost over net assets acquired, net of
 accumulated amortization of $20,650 in 1997 and
 $26,128 in 1996......................................     84,701      69,504
Noncurrent deferred income taxes......................     22,130       2,986
Other assets..........................................     12,906      13,662
                                                       ----------  ----------
                                                       $1,065,658  $1,097,613
                                                       ==========  ==========
         LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable and accrued liabilities............ $  172,700  $   77,737
  Amounts due to Sterling Commerce, Inc...............                 35,134
  Deferred revenue....................................     95,455      68,854
                                                       ----------  ----------
    Total current liabilities.........................    268,155     181,725
Noncurrent deferred revenue...........................     20,432      15,778
Other noncurrent liabilities..........................     28,817      20,619
Contingencies and commitments
Stockholders' equity:
  Common stock, $.10 par value; 75,000,000 shares
   authorized; 39,904,000 and 39,807,000 shares issued
   in 1997 and 1996, respectively.....................      3,990       3,981
  Additional paid-in capital..........................    806,021     804,451
  Retained earnings (deficit).........................     (3,506)    130,156
  Less treasury stock, at cost; 1,352,000 and
   1,372,000 shares in 1997 and 1996, respectively....    (58,251)    (59,097)
                                                       ----------  ----------
    Total stockholders' equity........................    748,254     879,491
                                                       ----------  ----------
                                                       $1,065,658  $1,097,613
                                                       ==========  ==========
</TABLE>
 
                            See accompanying notes.
 
                                       24
<PAGE>
 
                            STERLING SOFTWARE, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                 YEARS ENDED SEPTEMBER 30, 1997, 1996 AND 1995
                  (IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
 
<TABLE>
<CAPTION>
                                                   1997       1996      1995
                                                 ---------  --------  --------
<S>                                              <C>        <C>       <C>
Revenue:
  Products.....................................  $ 210,434  $192,464  $168,300
  Product support..............................    129,426   123,401   113,752
  Services.....................................    149,118   123,306   114,259
                                                 ---------  --------  --------
                                                   488,978   439,171   396,311
Costs and expenses:
 Cost of sales:
  Products and product support.................     69,783    72,201    57,726
  Services.....................................    130,023   110,038   103,009
                                                 ---------  --------  --------
                                                   199,806   182,239   160,735
  Product development and enhancement..........     23,114    20,921    27,702
  Selling, general and administrative..........    197,341   175,237   147,552
  Reorganization costs.........................    106,037              19,512
  Purchased research and development...........    137,849              62,000
                                                 ---------  --------  --------
                                                   664,147   378,397   417,501
                                                 ---------  --------  --------
Income (loss) from continuing operations before
 other income (expense) and income taxes.......   (175,169)   60,774   (21,190)
Other income (expense):
  Interest expense.............................       (540)   (3,361)   (8,582)
  Investment income............................     38,902    26,854     8,997
  Other........................................        411       619     2,119
                                                 ---------  --------  --------
                                                    38,773    24,112     2,534
                                                 ---------  --------  --------
Income (loss) from continuing operations before
 income taxes..................................   (136,396)   84,886   (18,656)
Provision (benefit) for income taxes...........     (3,428)   24,288    15,000
                                                 ---------  --------  --------
Income (loss) from continuing operations.......   (132,968)   60,598   (33,656)
Discontinued operations, net of applicable in-
 come taxes:
 Income from discontinued operations, net......               51,187    42,930
 Gain on the initial public offering of subsid-
  iary, net....................................              126,103
                                                 ---------  --------  --------
                                                             177,290    42,930
                                                 ---------  --------  --------
Net income (loss)..............................   (132,968)  237,888     9,274
Preferred stock dividends......................                            145
                                                 ---------  --------  --------
Income (loss) applicable to common stockhold-
 ers...........................................  $(132,968) $237,888  $  9,129
                                                 =========  ========  ========
Income (loss) per common share:
  Income (loss) from continuing operations
    Primary....................................  $   (3.45) $   1.78  $  (1.43)
                                                 =========  ========  ========
    Fully diluted..............................  $   (3.45) $   1.73  $  (1.43)
                                                 =========  ========  ========
  Net income (loss)
    Primary....................................  $   (3.45) $   6.98  $    .39
                                                 =========  ========  ========
    Fully diluted..............................  $   (3.45) $   6.65  $    .39
                                                 =========  ========  ========
</TABLE>
                            See accompanying notes.
 
                                       25
<PAGE>
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                 YEARS ENDED SEPTEMBER 30, 1997, 1996 AND 1995
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                 PREFERRED STOCK      COMMON STOCK                          TREASURY STOCK
                                 ------------------   --------------                        ----------------
                                  NUMBER              NUMBER          ADDITIONAL RETAINED   NUMBER                TOTAL
                                    OF        PAR       OF     PAR     PAID-IN   EARNINGS     OF              STOCKHOLDERS'
                                  SHARES     VALUE    SHARES  VALUE    CAPITAL   (DEFICIT)  SHARES    COST       EQUITY
                                 --------   -------   ------  ------  ---------- ---------  ------  --------  -------------
<S>                              <C>        <C>       <C>     <C>     <C>        <C>        <C>     <C>       <C>
Balance at September 30, 1994..        200   $    20  22,378  $2,238   $192,064  $    572    1,793  $(19,090)   $175,804
 Net income....................                                                     9,274                          9,274
 Preferred stock dividends.....                                                      (145)                          (145)
 Issuance of common stock and
  treasury stock for
  acquisition, net of issuance
  costs........................                          720      72     55,515             (1,701)   18,111      73,698
 Issuance of common stock
  pursuant to stock options
  and warrants, including tax
  benefit of $25,251...........                        3,431     343     88,505                                   88,848
 Issuance of common stock to
  retirement plan..............                                             607                (28)      304         911
 Other.........................       (200)      (20)                        61      (186)      (8)       93         (52)
                                  --------   -------  ------  ------   --------  --------   ------  --------    --------
Balance at September 30, 1995..                       26,529   2,653    336,752     9,515       56      (582)    348,338
 Net income....................                                                   237,888                        237,888
 Acquisition of common stock
  for treasury.................                                                              1,336   (59,372)    (59,372)
 Issuance of common stock
  pursuant to stock options
  and warrants, including tax
  benefit of $47,112...........                        9,222     922    322,827                                  323,749
 Issuance of common stock
  pursuant to conversion of
  5.75 % Debentures............                        4,056     406    111,970                                  112,376
 Proceeds from subsidiary
  initial public offering, net
  of minority interest of
  $7,382.......................                                          32,736                                   32,736
 Distribution of subsidiary....                                                  (113,549)                      (113,549)
 Issuance of common stock to
  retirement plan..............                                             127                (20)      857         984
 Adjustment to unrealized
  gains (losses) on available-
  for-sale securities, net of
  tax..........................                                                    (1,178)                        (1,178)
 Other.........................                                              39    (2,520)                        (2,481)
                                                      ------  ------   --------  --------   ------  --------    --------
Balance at September 30, 1996..                       39,807   3,981    804,451   130,156    1,372   (59,097)    879,491
 Net loss......................                                                  (132,968)                      (132,968)
 Issuance of common stock
  pursuant to stock options,
  including tax benefit of
  $450.........................                          104      10      1,865                                    1,875
 Issuance of common stock to
  retirement plan..............                                            (295)               (20)      845         550
 Adjustment to unrealized
  gains (losses) on available-
  for-sale securities, net of
  tax..........................                                                     2,381                          2,381
 Other.........................                           (7)     (1)              (3,075)                 1      (3,075)
                                                      ------  ------   --------  --------   ------  --------    --------
Balance at September 30, 1997..                       39,904  $3,990   $806,021  $ (3,506)   1,352  $(58,251)   $748,254
                                                      ======  ======   ========  ========   ======  ========    ========
</TABLE>
 
                            See accompanying notes.
 
                                       26
<PAGE>
 
                            STERLING SOFTWARE, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                 YEARS ENDED SEPTEMBER 30, 1997, 1996 AND 1995
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                    1997       1996      1995
                                                  ---------  --------  --------
<S>                                               <C>        <C>       <C>
Operating activities:
  Net income (loss).............................  $(132,968) $237,888  $  9,274
  Less: Income from discontinued operations.....             (177,290)  (42,930)
                                                  ---------  --------  --------
  Income (loss) from continuing operations......   (132,968)   60,598   (33,656)
  Adjustments to reconcile income (loss) from
   continuing operations to net cash provided by
   operating activities:
    Depreciation and amortization...............     34,520    31,599    27,916
    Provision for losses on accounts
     receivable.................................      3,950     4,857     4,351
    (Benefit) provision for deferred income
     taxes......................................    (19,145)   11,411     9,851
    Purchased research and development..........    137,849              62,000
    Reorganization costs........................     63,726               8,925
    Changes in operating assets and liabilities,
     net of effects of business acquisitions:
      Decrease (increase) in accounts and notes
       receivable...............................     28,294    (3,153)  (25,757)
      (Decrease) increase in amounts due to
       Sterling Commerce, Inc. .................    (35,134)   35,134
      Increase in prepaid expenses and other
       assets...................................     (1,095)  (16,109)   (4,973)
      Increase (decrease) in accounts payable,
       accrued liabilities and income taxes
       payable..................................     38,034   (61,541)   (4,852)
      Increase in deferred revenue..............        183       546     9,088
      Other.....................................      6,489    (2,181)      146
                                                  ---------  --------  --------
        Net cash provided by operating
         activities.............................    124,703    61,161    53,039
Investing activities:
  Purchases of property and equipment...........    (26,631)  (11,991)  (22,467)
  Purchases and capitalized cost of development
   of computer software.........................    (19,418)  (15,852)  (12,287)
  Business acquisitions, net of cash acquired...   (194,871)   (7,001)  (15,090)
  Purchases of investments......................   (255,888) (576,299) (143,827)
  Proceeds from sales of investments............    284,703   406,072   129,749
  Other.........................................        584       379       (88)
                                                  ---------  --------  --------
        Net cash used in investing activities...   (211,521) (204,692)  (64,010)
Financing activities:
  Purchases of treasury stock...................              (59,372)
  Preferred stock dividends.....................                           (145)
  Retirement and redemption of debt and capital
   lease obligations............................     (7,483)  (13,222)  (73,128)
  Proceeds from issuance of debt, net of
   issuance costs...............................      8,166     6,014    68,832
  Net proceeds from subsidiary public offering..              265,458
  Proceeds from issuance of common stock
   pursuant to the exercise of stock options and
   warrants.....................................      1,425   276,637    63,597
  Other.........................................     (1,487)   (4,162)   (3,270)
                                                  ---------  --------  --------
        Net cash provided by financing
         activities.............................        621   471,353    55,886
Cash flows provided by discontinued operations..               17,819    32,354
Effect of foreign currency exchange rate changes
 on cash........................................     (2,314)     (314)      127
                                                  ---------  --------  --------
(Decrease) increase in cash and equivalents.....    (88,511)  345,327    77,396
Cash and cash equivalents at beginning of year..    524,237   178,910   101,514
                                                  ---------  --------  --------
Cash and cash equivalents at end of year........  $ 435,726  $524,237  $178,910
                                                  =========  ========  ========
Supplemental cash flow information:
  Interest paid.................................  $     540  $  4,453  $  7,968
                                                  =========  ========  ========
  Income taxes paid.............................  $   6,308  $ 91,902  $ 10,243
                                                  =========  ========  ========
</TABLE>
 
                            See accompanying notes.
 
                                       27
<PAGE>
 
                            STERLING SOFTWARE, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                       SEPTEMBER 30, 1997, 1996 AND 1995
 
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  The Company
 
  Sterling Software, Inc. ("Sterling Software" or the "Company") was founded in
198l and became a publicly owned corporation in 1983. Sterling Software is a
recognized worldwide supplier of software products and services within three
major markets: systems management, applications management and federal systems.
Consistent with Sterling Software's decentralized operating structure, major
markets are served by independently operated business groups which consist of
divisions and business units that focus on specific business niches within
those markets. Sterling Software believes that its decentralized organizational
structure promotes operating flexibility, improves responsiveness to customer
requirements and focuses management on achieving revenue and operating profit
objectives. Sterling Software has historically expanded its operations through
internal growth and by business and product acquisitions.
 
  Basis of Presentation
 
  The consolidated financial statements include the accounts of Sterling
Software after elimination of all significant intercompany balances and
transactions. Certain amounts for periods ended prior to September 30, 1997,
have been reclassified to conform to the current year presentation. The
financial statements have been prepared in conformity with generally accepted
accounting principles which require management to make estimates and
assumptions that affect the reported amounts of assets, liabilities and the
disclosure of contingencies at September 30, 1997 and 1996 and the results of
operations for the years ended September 30, 1997, 1996 and 1995. While
management has based their assumptions and estimates on the facts and
circumstances currently known, final amounts may differ from such estimates.
 
  Revenue
 
  Revenue from license fees, including leasing transactions, for standard
software products is recognized when the software is delivered, provided no
significant future vendor obligations exist and collection is probable. Service
revenue and revenue from products involving installation or other services are
recognized as the services are performed.
 
  Product support contracts allow customers to receive updated versions of
Sterling Software's products when and if they become available, as well as bug
fixing, and Internet and telephone access to the Company's technical personnel.
Revenue from product support contracts, including product support included in
initial license fees, is recognized ratably over the contract period. All
significant costs and expenses associated with product support contracts are
expensed ratably over the contract period.
 
  If software product transactions include the right to receive future
products, a portion of the software product revenue is deferred and recognized
as products are delivered. Contract accounting is applied for sales of software
products requiring significant modification or customization, such that revenue
is recognized only when the modification or customization is complete.
 
  When products, product support, and services are billed prior to the time the
related revenue is recognized, deferred revenue is recorded and related costs
paid in advance are deferred.
 
  Revenue from specialized information technology ("IT") services provided to
the federal government under multi-year contracts is recognized as the services
are performed. Revenue for services provided under other long-term contracts is
recognized using the percentage-of-completion method of accounting. Losses on
long-term
 
                                       28
<PAGE>
 
contracts are recognized when the current estimate of total contract costs
indicates a loss on a contract is probable.
 
  Software Development Costs
 
  The Company capitalizes the costs of developing and testing new or
significantly enhanced software products in accordance with the provisions of
Statement of Financial Accounting Standard No. 86 ("FAS 86"), "Accounting for
the Costs of Computer Software to be Sold, Leased or Otherwise Marketed".
Unamortized software development costs of $40,116,000 and $36,242,000 are
included in "Computer software, net" at September 30, 1997 and 1996,
respectively.
 
  Pursuant to FAS 86, costs are capitalized when technological feasibility of
the product is established. Technological feasibility is established either
upon the completion of a detailed program design or the completion of a
working model. The establishment of technological feasibility and the ongoing
assessment of recoverability of capitalized software development costs require
judgment by management with respect to certain external factors, including,
but not limited to, anticipated future revenues, estimated economic life and
changes in software and hardware technologies. Software development
capitalized costs include, among other things, programmers salaries and
benefits, outside contractor costs, computer time and allocated facilities
costs.
 
  Depreciation and Amortization
 
  Property and equipment are recorded at cost and depreciated using the
straight-line method over average useful lives of three to 20 years. Computer
software costs are amortized on a product-by-product basis using the greater
of the amount computed by taking the ratio of current year net revenue to
estimated future net revenue or the amount computed by the straight-line
method over periods ranging from three to seven years. Excess costs over the
net assets of businesses acquired are amortized on a straight-line basis over
periods of seven to 40 years. Other intangible assets are amortized on a
straight-line basis over periods of three to ten years.
 
  Depreciation and amortization consists of the following for the years ended
September 30, 1997, 1996 and 1995 (in thousands):
 
<TABLE>
<CAPTION>
                                                        1997    1996    1995
                                                       ------- ------- -------
   <S>                                                 <C>     <C>     <C>
   Property and equipment............................. $13,644 $11,463 $ 9,922
   Purchased computer software........................   6,731   5,926   4,203
   Capitalized computer software development costs....   9,605   7,871   8,505
   Excess costs over net assets of businesses ac-
    quired............................................   4,278   5,839   4,894
   Intangible assets..................................     262     500     392
                                                       ------- ------- -------
                                                       $34,520 $31,599 $27,916
                                                       ======= ======= =======
</TABLE>
 
  Income Taxes
 
  The Company's income taxes are presented in accordance with the provisions
of Statement of Financial Accounting Standard No. 109 ("FAS 109"), "Accounting
for Income Taxes," which requires the use of the asset and liability method of
accounting for income taxes. Under the asset and liability method, a deferred
tax asset or liability is recognized for estimated future tax effects
attributable to temporary differences and carryforwards. The measurement of
deferred income tax assets is adjusted by a valuation allowance, if necessary,
to recognize future tax benefit only to the extent, based on available
evidence, it is more likely than not it will be realized.
 
  Stock Options
 
  The Company has elected to follow Accounting Principles Board Opinion No. 25
("APB 25"), "Accounting for Stock Issued to Employees," in accounting for its
employee stock options and stock based
 
                                      29
<PAGE>
 
awards. Under APB 25, if the exercise price of an employee's stock option
equals or exceeds the market price of the underlying stock on the date of
grant, no compensation expense is recognized. The Company will provide pro
forma disclosures as required under Statement of Financial Accounting Standard
No. 123 ("FAS 123"), "Accounting for Stock-Based Compensation".
 
  Earnings Per Common Share
 
  Primary earnings per common share data is computed using the weighted average
number of common shares and common share equivalents represented by stock
options and warrants, if such stock options and warrants have a dilutive effect
in the aggregate. For purposes of this computation, income applicable to common
stockholders is adjusted to reflect use of net cash proceeds on the assumed
exercise of stock options and warrants to purchase outstanding long-term debt
or government securities, if such stock options and warrants have a dilutive
effect in the aggregate.
 
  For the years ended September 30, 1997 and 1995, the net loss per common
share calculations for such periods is based on the weighted average number of
common shares outstanding during the year. The numbers of shares used in the
computations of net loss per common share was 38,494,000 and 23,649,000 for the
years ended September 30, 1997 and 1995, respectively. The numbers of shares
used in the computations of primary and fully diluted income per common share
for the year ended September 30, 1996 were 34,071,000 and 36,045,000,
respectively.
 
  In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 128 ("FAS 128"), "Earnings Per
Share," which is required to be adopted for both interim and annual financial
statements for periods ending after December 15, 1997. At that time, the
Company will be required to change the method currently used to compute
earnings per share and to restate all prior periods. This change is expected to
result in restated earnings per share as follows:
 
<TABLE>
<CAPTION>
                                                              YEARS ENDED
                                                             SEPTEMBER 30
                                                          --------------------
                                                           1997   1996   1995
                                                          ------  ----- ------
   <S>                                                    <C>     <C>   <C>
   Income (loss) from continuing operations:
     Basic............................................... $(3.45) $1.88 $(1.43)
     Diluted............................................. $(3.45) $1.75 $(1.43)
   Net income (loss):
     Basic............................................... $(3.45) $7.36 $  .39
     Diluted............................................. $(3.45) $6.73 $  .39
</TABLE>
 
  Foreign Currency Translation
 
  The assets and liabilities of the Company's non-U.S. operations are
translated into U.S. dollars at exchange rates in effect as of the respective
balance sheet dates, and revenue and expense accounts of these operations are
translated at average exchange rates during the month the transactions occur.
Unrealized translation gains and losses are included as an adjustment to
retained earnings.
 
  Cash and Equivalents
 
  Cash equivalents consist primarily of highly liquid investments in
investment-grade commercial paper of various issuers and repurchase agreements
backed by U.S. Treasury securities, with maturities of three months or less
when purchased. Cash equivalents are recorded at fair value.
 
  Marketable Securities and Other Investments
 
  The Company currently invests excess cash in a diversified portfolio of
marketable securities consisting of a variety of investment-grade securities,
including commercial paper, medium-term notes, U.S. government
 
                                       30
<PAGE>
 
obligations and certificates of deposit. The fair values for marketable
securities are based on quoted market prices.
 
  All marketable securities and long-term investments are classified as
available-for-sale securities. Unrealized holding gains and losses on
securities available-for-sale are recorded as a component of stockholders'
equity, net of any related tax effect. The amortized cost of debt securities
in this category is adjusted for amortization of premiums and accretion of
discounts to maturity. Such amortization is included in investment income.
Realized gains and losses and declines in values judged to be other-than-
temporary, if any, on available-for-sale securities are included in investment
income.
 
  Excess Cost Over Net Assets Acquired
 
  Excess cost over net assets acquired is amortized on a straight-line basis
over periods of seven to 40 years. The carrying amount of such costs which are
not associated with other assets acquired in a purchase business combination
is reviewed by management if facts and circumstances suggest that such amount
may be impaired. If this review indicates that the costs will not be
recoverable, as determined based on the estimated discounted future cash flows
of the entity acquired over the remaining amortization period, the carrying
amount is reduced by the estimated shortfall of cash flows. The carrying
amount of costs associated with other assets acquired in a purchase business
combination is included in impairment evaluations when events or circumstances
exist that indicate the carrying amount of those assets may not be
recoverable.
 
  Recent Developments
 
  In October 1997 the FASB approved the American Institute of Certified Public
Accountants Statement of Position ("SOP 97-2"), "Software Revenue
Recognition," which will be effective for transactions occurring after
September 30, 1998. The Company's accounting policy for software revenue
recognition is generally in compliance with SOP 97-2 and its adoption is not
expected to have a material impact on the financial position or results of
operations of the Company.
 
  In June 1997 the FASB issued Statement of Financial Accounting Standard No.
130 ("FAS 130"), "Reporting Comprehensive Income". FAS 130 establishes
standards for reporting and display of comprehensive income and its components
in a full set of general-purpose financial statements. FAS 130 is effective
for fiscal years beginning after December 15, 1997. The adoption of FAS 130
will require additional disclosure in the Company's financial statements but
will not have any impact on the financial position or results of operations of
the Company.
 
  Also in June 1997, the FASB issued Statement of Financial Accounting
Standard No. 131 ("FAS 131"), "Disclosures about Segments of an Enterprise and
Related Information". FAS 131 establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
stockholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. FAS 131 is
effective for financial statements for fiscal years beginning after December
15, 1997. The adoption of FAS 131 is not expected to have a material impact on
the information the Company currently discloses about its business segments.
 
2. BUSINESS ACQUISITIONS AND REORGANIZATIONS
 
  Acquisition of TI Software
 
  On June 30, 1997, Sterling Software completed the acquisition (the
"Acquisition") of certain assets (including the capital stock of certain
foreign subsidiaries) of Texas Instruments Incorporated ("Texas Instruments").
Such assets constituted substantially all of the assets used by Texas
Instruments' Software Division ("TI Software") in its business of developing,
marketing, licensing, supporting and maintaining
 
                                      31
<PAGE>
 
application development software and providing related consulting services.
The results of operations of TI Software are included in the Company's results
of operations from the date of the Acquisition.
 
  The cash purchase price paid for such assets was $165,000,000 and was funded
from the Company's available cash balances. The total cost of the Acquisition
was approximately $214,774,000, including costs directly related to the
Acquisition of approximately $49,774,000, consisting of employee termination
costs, transaction costs, costs associated with the elimination of duplicate
facilities and other direct costs. The components of the aggregate cost were
as follows (in thousands):
 
<TABLE>
   <S>                                                                 <C>
   Cash paid to Texas Instruments..................................... $165,000
   TI Software employee severance and benefits........................   28,696
   Elimination of duplicate facilities and leases of TI Software......   10,578
   Transaction costs..................................................    4,904
   Other costs........................................................    5,596
                                                                       --------
                                                                       $214,774
                                                                       ========
</TABLE>
 
  The Acquisition has been accounted for in accordance with the purchase
method of accounting. The aggregate purchase price has been allocated to the
assets and liabilities acquired, with the remainder recorded as excess cost
over net assets acquired, based on estimates of fair values as follows (in
thousands):
 
<TABLE>
   <S>                                                                <C>
   Working capital (deficit)......................................... $(10,100)
   Property and equipment............................................    4,530
   Software..........................................................   24,054
   Purchased research and development costs charged to expense.......  137,849
   Other liabilities.................................................      (32)
   Excess cost over net assets acquired..............................   58,473
                                                                      --------
                                                                      $214,774
                                                                      ========
</TABLE>
 
  The estimates of fair value were determined by the Company's management
based on information furnished by the management of TI Software and an
independent valuation of acquired software and research and development. The
cost of the Acquisition which was allocable to purchased research and
development costs was charged to expense in 1997 in accordance with the
purchase method of accounting.
 
  The following unaudited pro forma information presents the Company's results
of operations as if the Acquisition had occurred at October 1, 1996. The pro
forma information has been prepared by combining the results of operations of
the Company and TI Software for the years ended September 30, 1997 and 1996,
adjusted for the elimination of charges for purchased research and development
costs and reorganization costs, additional amortization expense and the
resulting impact on the provision for income taxes. This pro forma information
does not purport to be indicative of what would have occurred had the
Acquisition and related reorganization occurred as of that date or of results
of operations which may occur in the future (in thousands, except per share
data):
 
<TABLE>
<CAPTION>
                                                                 YEARS ENDED
                                                                SEPTEMBER 30
                                                              -----------------
                                                                1997     1996
                                                              -------- --------
   <S>                                                        <C>      <C>
   Revenue................................................... $653,353 $709,660
   Income before other income (expense) and income taxes..... $ 40,400 $ 54,146
   Income from continuing operations......................... $ 50,769 $ 50,785
   Income from continuing operations per share............... $   1.28 $   1.46
</TABLE>
 
 
                                      32
<PAGE>
 
  Acquisition of KnowledgeWare
 
  On November 30, 1994, Sterling Software acquired KnowledgeWare, Inc.
("KnowledgeWare"), a provider of applications development software and
services, for approximately $106,000,000, in a stock-for-stock acquisition
(the "Merger") accounted for in accordance with the purchase method of
accounting. In connection with the Merger, the Company issued approximately
2,421,000 shares of the Company's common stock, par value $0.10 per share
("Common Stock"), valued at approximately $74,443,000 and reserved
approximately 340,000 shares of Common Stock for issuance upon exercise of
KnowledgeWare's options and warrants. In addition, the Company incurred costs
directly related to the Merger of approximately $31,672,000.
 
  The results of operations of KnowledgeWare are included in the Company's
results of operations from the date of the Merger. In addition, the 1995
results of operations include $62,000,000 of purchased research and
development costs charged to expense in accordance with the purchase method of
accounting.
 
  Reorganization Costs
 
  The Company's 1997 results of operations include costs of $106,037,000
primarily related to the reorganization of the Company's operations in
connection with the Acquisition and the termination of the International
Distributor Agreement dated March 4, 1996 (the "International Distributor
Agreement") with Sterling Commerce, Inc. ("Sterling Commerce"), formerly a
wholly owned subsidiary of Sterling Software formed to operate the business of
Sterling Software's former Electronic Commerce Group. These reorganization
costs also include the write-down of certain excess cost over net assets
acquired related to the Company's federal systems business. Of the total
reorganization costs, approximately $63,726,000 consisted of non-cash costs
and the remaining $42,311,000 required cash outlays, $13,504,000 of which had
been paid as of September 30, 1997. The components of the reorganization costs
were as follows (in thousands):
 
<TABLE>
   <S>                                                                 <C>
   Employee termination costs........................................  $ 18,539
   Write-down of software products which will not be actively market-
    ed...............................................................    17,591
   Write-down of excess cost over net assets acquired................    38,955
   Elimination of duplicate facilities and equipment.................    19,993
   Out of pocket costs related to the reorganization.................     5,109
   Other costs.......................................................     5,850
                                                                       --------
                                                                       $106,037
                                                                       ========
</TABLE>
 
  The Company's 1995 results of operations include reorganization costs of
$19,512,000 primarily related to the reorganization of the Company's
operations in connection with the Merger with KnowledgeWare. Of the total
reorganization costs, approximately $8,377,000 consisted of non-cash costs and
the remaining $11,135,000 required cash outlays, substantially all of which
had been paid as of September 30, 1996.
 
3. DISCONTINUED OPERATIONS
 
  Sterling Commerce completed the initial public offering (the "Offering") of
13,800,000 shares of its common stock, par value $0.01 per share ("Commerce
Stock"), on March 13, 1996. Pursuant to the Offering, Sterling Software sold
to the public 12,000,000 of its 73,200,000 shares of Commerce Stock and
Sterling Commerce sold 1,800,000 of previously unissued shares of Commerce
Stock. The Offering price was $24 per share of Commerce Stock, resulting in
net proceeds to Sterling Software of approximately $265,458,000 after
deducting underwriting discounts and commissions and Sterling Software's pro
rata share of Offering expenses. Sterling Software recorded a gain of
approximately $126,103,000, net of tax, from the sale of Commerce Stock in the
Offering.
 
  On September 30, 1996, Sterling Software completed the spin-off of Sterling
Commerce with the pro rata distribution (the "Distribution") of its remaining
81.6% ownership in Sterling Commerce to Sterling Software's stockholders by
means of a tax-free dividend. Holders of record of Common Stock as of the
close of business on
 
                                      33
<PAGE>
 
September 30, 1996 received 1.59260 shares of Commerce Stock for each share of
Common Stock owned on such date. The Distribution resulted in the reduction of
Sterling Software's stockholders' equity in the amount of $113,549,000,
representing the book value of net assets distributed.
 
  The results of operations of Sterling Commerce for 1996 and 1995 have been
classified as discontinued operations. The income from discontinued operations
reflected in the table below is inclusive of minority interest held by
stockholders other than Sterling Software. Summary operating results of
discontinued operations are as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                                 YEARS ENDED
                                                                SEPTEMBER 30
                                                              -----------------
                                                                1996     1995
                                                              -------- --------
     <S>                                                      <C>      <C>
     Revenue................................................. $267,773 $203,578
     Total costs and expenses................................ $172,568 $131,550
     Income before income taxes.............................. $ 96,422 $ 71,550
     Income taxes............................................ $ 38,030 $ 28,620
     Income from discontinued operations, net................ $ 58,392 $ 42,930
</TABLE>
 
  In anticipation of the Offering, Sterling Software and Sterling Commerce
entered into a number of agreements (the "Intercompany Agreements") for the
purpose of defining certain relationships between them. As a result of Sterling
Software's then ownership interest in Sterling Commerce, the terms of such
Intercompany Agreements were not the result of arm's-length negotiation. The
Intercompany Agreements included a tax allocation agreement, an indemnification
agreement and the International Distributor Agreement. The tax allocation
agreement provides that for periods during which Sterling Commerce and/or its
subsidiaries are included in the Company's consolidated federal income tax
returns or consolidated, combined or unitary state tax returns (which periods
include the period between the Offering and the Distribution), the Company is
required to pay to or entitled to receive from Sterling Commerce its allocable
portion of the consolidated federal and state income tax liability or refunds,
respectively. The indemnification agreement provides, among other things, that
each party thereto (the "Indemnifying Party") will indemnify the other party
thereto and its directors, officers, employees, agents and representatives
(each, an "Indemnified Party") for liabilities that may be incurred by an
Indemnified Party relating to (i) the businesses, operations or assets
conducted or owned or formerly conducted or owned by the Indemnifying Party and
its subsidiaries (except, in the case where the Company is the Indemnifying
Party, the businesses, operations and assets of Sterling Commerce and its
subsidiaries) or (ii) the failure by the Indemnifying Party to comply with any
other agreements executed in connection with the Offering. In addition, the
indemnification agreement provides that Sterling Commerce will indemnify the
Company and its directors, officers, employees, agents and representatives for
any liabilities resulting from or arising out of certain acts, failures to act
or the provision of incorrect factual information by Sterling Commerce in
connection with the Internal Revenue Service ("IRS") ruling request that cause
the Distribution to be taxable to the Company or its stockholders. The
International Distributor Agreement, which was terminated effective as of June
30, 1997 as described below, defined the terms pursuant to which the Company
acted as the exclusive distributor of certain Sterling Commerce products in
markets outside the United States and Canada.
 
  Pursuant to a Termination Agreement dated June 30, 1997, by and between
Sterling Software and Sterling Commerce, the International Distributor
Agreement was terminated. Contemporaneously with such termination, Sterling
Software sold to Sterling Commerce certain of the assets formerly used by
Sterling Software in connection with the distribution of certain Sterling
Commerce products outside the United States and Canada. In addition, Sterling
Software and Sterling Commerce entered into certain short-term transitional
arrangements relating to facilities sharing and administrative and other
services.
 
  In consideration of the termination of the International Distributor
Agreement and the sale of assets described above, Sterling Commerce (i) paid to
Sterling Software $5,226,000 on June 30, 1997, (ii) subsequently paid to
Sterling Software $10,076,000, which was equal to the net book value of the
acquired assets, and (iii) assumed certain liabilities of Sterling Software.
 
                                       34
<PAGE>
 
  As a result of various transactions between the Company and Sterling
Commerce, including royalties due to Sterling Commerce as a result of the
Company acting as an international distributor, tax and other expenses charged
to Sterling Commerce and Sterling Commerce's participation in the Company's
central cash management program (which participation terminated upon
completion of the Distribution on September 30, 1996), amounts payable and
receivable from Sterling Commerce arise from time to time. At September 30,
1996, the Company had amounts due to Sterling Commerce of $35,134,000, which
were remitted to Sterling Commerce subsequent to September 30, 1996.
 
4. LEGAL PROCEEDINGS AND CLAIMS
 
  On November 30, 1994, Sterling Software acquired KnowledgeWare in a stock-
for-stock acquisition. On March 14, 1995, the Securities and Exchange
Commission (the "Commission") entered an Order Directing Private Investigation
and Designating Officers to take Testimony titled "In the Matter of
KnowledgeWare, Inc. (NY-6231)". The investigation generally relates to (i)
trading in KnowledgeWare securities from July 1, 1992 through the time of the
stock-for-stock transaction by which Sterling Software acquired KnowledgeWare,
(ii) KnowledgeWare's compliance with the Commission's filing and reporting
obligations and (iii) the adequacy and/or accuracy of KnowledgeWare's public
disclosures, recordkeeping and accounting controls. In addition to the
potential liability of the Company's wholly owned subsidiary that was the
surviving corporation in the KnowledgeWare Merger, Sterling Software may have
an indemnity obligation with respect to certain individuals who may be subject
to the Commission's investigation. While any legal investigation or proceeding
involves inherent uncertainty, Sterling Software's management believes based
upon presently available information that the ultimate resolution of the
Commission's investigation will not materially affect the financial condition
or results of operations of the Company.
 
  The Company is also subject to certain legal proceedings and claims that
arise in the normal course of its business. In the opinion of management, the
amount of the liability, if any, ultimately incurred by Sterling Software with
respect to any existing proceedings and claims, net of applicable reserves and
available insurance, will not materially affect the financial condition or
results of operations of the Company.
 
5. SEGMENT INFORMATION
 
  The Company acquires, develops, markets and supports a broad range of
computer software products and services in three major markets: systems
management, applications management and federal systems. Major markets are
represented through independently operated business segments. The systems
management business segment provides products that enable customers to ensure
the quality of service of IT applications across enterprise networked
computing environments. The applications management business segment provides
application development products and services for business modeling through
code generation, as well as products and services that enable customers to
extend the life and usefulness of legacy applications and to facilitate
enterprise information access. The federal systems business segment provides
specialized IT services to the federal government under numerous multi-year
contracts primarily in support of two major customers, the National
Aeronautics and Space Administration and the Department of Defense. Through
June 30, 1997, the Company sold, marketed and provided first-level support
outside of the United States and Canada for Sterling Commerce's interchange
and communications software products, the results of which are included in the
business segment information under "Corporate and other".
 
 
                                      35
<PAGE>
 
  Financial information concerning the Company's operations, by business
segment, for the years ended September 30, 1997, 1996 and 1995, is summarized
as follows (in thousands):
 
<TABLE>
<CAPTION>
   INDUSTRY SEGMENTS                             1997        1996       1995
   -----------------                          ----------  ----------  --------
   <S>                                        <C>         <C>         <C>
   Revenue:
     Systems Management.....................  $  184,679  $  170,804  $154,657
     Applications Management................     142,942     109,804   107,209
     Federal Systems........................     121,790     112,188   101,702
     Corporate and other....................      39,567      46,375    32,743
                                              ----------  ----------  --------
       Consolidated totals..................  $  488,978  $  439,171  $396,311
                                              ==========  ==========  ========
   Operating Profit (Loss):
     Systems Management.....................  $   70,629  $   65,858  $ 55,471
     Applications Management................      20,842      16,408    21,320
     Federal Systems........................       8,689       7,982     6,648
     Reorganization costs...................    (106,037)              (19,512)
     Purchased research and development.....    (137,849)              (62,000)
     Corporate and other....................     (31,443)    (29,474)  (23,117)
                                              ----------  ----------  --------
       Consolidated totals..................  $ (175,169) $   60,774  $(21,190)
                                              ==========  ==========  ========
   Identifiable Assets:
     Systems Management.....................  $  150,549  $  135,845  $115,729
     Applications Management................     194,641     107,713   125,410
     Federal Systems........................      58,445      68,809    56,737
     Corporate and other....................     662,023     785,246   306,648
     Discontinued operations................                            53,187
                                              ----------  ----------  --------
       Consolidated totals..................  $1,065,658  $1,097,613  $657,711
                                              ==========  ==========  ========
   Capital Expenditures (including additions
    to computer software):
     Systems Management.....................  $   16,919  $   14,597  $ 11,808
     Applications Management................       8,968       6,603     7,753
     Federal Systems........................       1,284       1,255     1,518
     Corporate and other....................      18,878       5,388    13,675
                                              ----------  ----------  --------
       Consolidated totals..................  $   46,049  $   27,843  $ 34,754
                                              ==========  ==========  ========
   Depreciation and Amortization:
     Systems Management.....................  $   16,014  $   12,230  $ 10,612
     Applications Management................      13,674      12,926    11,390
     Federal Systems........................       2,231       2,290     2,196
     Corporate and other....................       2,601       4,153     3,718
                                              ----------  ----------  --------
       Consolidated totals..................  $   34,520  $   31,599  $ 27,916
                                              ==========  ==========  ========
   Revenue from the U.S. Government:
     Systems Management.....................  $    4,140  $    3,521  $  3,250
     Applications Management................       7,455       5,169     2,930
     Federal Systems........................     112,802     104,052    97,650
                                              ----------  ----------  --------
       Consolidated totals..................  $  124,397  $  112,742  $103,830
                                              ==========  ==========  ========
</TABLE>
 
  The amounts presented for "Corporate and other" include corporate expense,
cash balances, marketable securities, long-term investments, deferred income
tax balances, other assets, the results of operations and assets of the
Company's retail software division, and, through June 30, 1997, the results of
operations relating to the international distribution of certain Sterling
Commerce products.
 
                                      36
<PAGE>
 
6. OPERATIONS BY GEOGRAPHIC AREA
 
  The Company's operations in the United States and international markets at
September 30, 1997, 1996 and 1995 and for the years then ended are summarized
as follows (in thousands):
 
<TABLE>
<CAPTION>
   GEOGRAPHICAL SEGMENT INFORMATION              1997        1996       1995
   --------------------------------           ----------  ----------  --------
   <S>                                        <C>         <C>         <C>
   Revenue:
     United States........................... $  294,273  $  252,181  $225,923
     Europe..................................    106,848      88,611    89,659
     Pacific.................................     33,789      36,905    35,185
     Canada and Latin America................     14,501      15,099    12,801
     Corporate and other.....................     39,567      46,375    32,743
                                              ----------  ----------  --------
                                              $  488,978  $  439,171  $396,311
                                              ==========  ==========  ========
   Operating Profit (Loss):
     United States........................... $   74,948  $   72,824  $ 54,940
     Europe..................................     12,664       9,773    16,925
     Pacific.................................      7,265       3,970     7,242
     Canada and Latin America................      5,283       3,681     4,332
     Reorganization costs....................   (106,037)              (19,512)
     Purchased research and development......   (137,849)              (62,000)
     Corporate and other.....................    (31,443)    (29,474)  (23,117)
                                              ----------  ----------  --------
                                              $ (175,169) $   60,774  $(21,190)
                                              ==========  ==========  ========
   Identifiable Assets:
     United States........................... $  226,944  $  217,021  $200,527
     Europe..................................    145,111      82,537    77,856
     Pacific.................................     25,900       9,236    15,055
     Canada and Latin America................      5,680       3,573     4,438
     Corporate and other.....................    662,023     785,246   306,648
     Discontinued operations.................                           53,187
                                              ----------  ----------  --------
                                              $1,065,658  $1,097,613  $657,711
                                              ==========  ==========  ========
</TABLE>
 
  The amounts presented for "Corporate and other" include corporate expense,
cash balances, marketable securities, long-term investments, deferred income
tax balances, other assets, the results of operations of the Company's retail
software division, and, through June 30, 1997, the results of operations
relating to the international distribution of certain Sterling Commerce
products.
 
7. MARKETABLE SECURITIES AND OTHER LONG-TERM INVESTMENTS
 
  At September 30, 1997 and 1996, all of the Company's marketable securities
and other long-term investments were classified as available-for-sale and
consist of the following (in thousands):
 
<TABLE>
<CAPTION>
                                                                     GROSS
                                                                  UNREALIZED
                                                                ---------------
                                            AGGREGATE AMORTIZED
                                              FAIR      COST    HOLDING HOLDING
                                              VALUE     BASIS    GAINS  LOSSES
                                            --------- --------- ------- -------
   <S>                                      <C>       <C>       <C>     <C>
   September 30, 1997
    Commercial paper....................... $ 14,887  $ 14,887
    U.S. corporate notes...................   96,520    96,337  $  291   $(108)
    U.S. government obligations............   14,947    15,018             (71)
    Municipal obligations..................   74,140    73,982     161      (3)
    Other..................................    6,471     4,864   1,607
                                            --------  --------  ------   -----
                                            $206,965  $205,088  $2,059   $(182)
                                            ========  ========  ======   =====
</TABLE>
 
                                      37
<PAGE>
 
<TABLE>
<CAPTION>
                                                                    GROSS
                                                                 UNREALIZED
                                                               ---------------
                                           AGGREGATE AMORTIZED
                                             FAIR      COST    HOLDING HOLDING
                                             VALUE     BASIS    GAINS  LOSSES
                                           --------- --------- ------- -------
   <S>                                     <C>       <C>       <C>     <C>
   September 30, 1996
    Commercial paper...................... $ 33,468  $ 33,468
    U.S. corporate notes..................   76,115    76,577   $ 25   $  (487)
    U.S. government obligations...........   76,062    76,265     89      (292)
    Municipal obligations.................   25,507    25,501      6
    Other.................................   20,767    21,889     28    (1,150)
                                           --------  --------   ----   -------
                                           $231,919  $233,700   $148   $(1,929)
                                           ========  ========   ====   =======
</TABLE>
 
  At September 30, 1997, scheduled maturities of investments in debt
securities are: $96,325,450 principal amount within one year and $104,160,651
principal amount between one and five years.
 
8. ACCOUNTS AND NOTES RECEIVABLE
 
  Accounts and notes receivable consist of the following at September 30 (in
thousands):
 
<TABLE>
<CAPTION>
                                                                1997     1996
                                                              -------- --------
     <S>                                                      <C>      <C>
     Trade................................................... $141,981 $115,427
     Unbilled................................................   19,593   24,032
                                                              -------- --------
                                                               161,574  139,459
     Less: Allowance for doubtful accounts...................   12,152    6,076
                                                              -------- --------
                                                              $149,422 $133,383
                                                              ======== ========
</TABLE>
 
  At September 30, 1997 and 1996, accounts receivable include $38,806,000 and
$35,975,000, respectively, due under contracts with the federal government and
related agencies. The remainder of the Company's receivables are due
principally from corporations in diverse industries located in North America,
Europe and Asia Pacific, which mitigates exposure to concentrations of credit
risk. Trade receivables are generally not collateralized. The Company performs
periodic credit evaluations of its customers' financial conditions.
 
9. PROPERTY AND EQUIPMENT
 
  Property and equipment consist of the following at September 30 (in
thousands):
 
<TABLE>
<CAPTION>
                                                                 1997    1996
                                                                ------- -------
     <S>                                                        <C>     <C>
     Computer and peripheral equipment......................... $39,734 $38,663
     Furniture, fixtures and other equipment...................  35,731  33,067
     Leasehold improvements....................................  15,563   9,629
                                                                ------- -------
                                                                 91,028  81,359
     Less: Accumulated depreciation............................  42,430  42,029
                                                                ------- -------
                                                                $48,598 $39,330
                                                                ======= =======
</TABLE>
 
10. LONG-TERM DEBT
 
  Effective July 1, 1997, the Company entered into an amended Revolving Credit
Agreement ("Credit Agreement") with an unsecured borrowing capacity of
$35,000,000. The Credit Agreement requires that certain financial ratios be
maintained. Borrowings under the Credit Agreement will bear interest at the
lower of the lender's base rate or the Eurodollar lending rate plus one-half
percent and will mature on June 30, 2000. No amounts were borrowed during 1997
or outstanding under the Credit Agreement at September 30, 1997. At September
30, 1997, after the utilization of approximately $1,443,000 for standby
letters of credit, approximately $33,557,000 was available for borrowing under
the Credit Agreement. Certain of the Company's foreign subsidiaries have
separate lines of credit totaling $21,305,000 that are used for foreign
exchange exposure management and working capital requirements. These lines of
credit are guaranteed by Sterling Software, Inc. At September 30, 1997,
$1,081,000 was outstanding pursuant to these foreign lines of credit.
 
                                      38
<PAGE>
 
  On December 20, 1995, the Company gave notice of the redemption of all of
the $114,922,000 then outstanding principal amount of its 5.75% Convertible
Subordinated Debentures (the "Debentures"), effective February 12, 1996.
Approximately $114,912,000 principal amount of the Debentures were converted
into 4,056,000 shares of Common Stock.
 
11. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
 
  Accounts payable and accrued liabilities consist of the following at
September 30 (in thousands):
 
<TABLE>
<CAPTION>
                                                                 1997    1996
                                                               -------- -------
     <S>                                                       <C>      <C>
     Trade accounts payable................................... $ 41,777 $16,712
     Accrued compensation.....................................   49,728  37,242
     Accrued acquisition and reorganization costs.............   45,545   4,017
     Other accrued liabilities................................   35,650  19,766
                                                               -------- -------
                                                               $172,700 $77,737
                                                               ======== =======
</TABLE>
 
  Accrued acquisition and reorganization costs at September 30, 1997 are
primarily due to the Acquisition and subsequent reorganization and are
primarily for the remaining commitments pursuant to employee termination costs
and the elimination of duplicate facilities and equipment.
 
12. INCOME TAXES
 
  The provision (benefit) for income taxes on income (loss) from continuing
operations is composed of the following (in thousands):
 
<TABLE>
<CAPTION>
                                                        YEARS ENDED SEPTEMBER
                                                                 30
                                                       -------------------------
                                                        1997     1996     1995
                                                       -------  -------  -------
   <S>                                                 <C>      <C>      <C>
   Current:
     Federal.......................................... $11,309  $10,055  $ 4,449
     State............................................   2,310
     Foreign..........................................   2,098    2,822      700
   Deferred:
     Federal.......................................... (17,330)  10,551    9,087
     State............................................  (1,685)   2,970      764
     Foreign..........................................    (130)  (2,110)
                                                       -------  -------  -------
                                                       $(3,428) $24,288  $15,000
                                                       =======  =======  =======
</TABLE>
 
                                      39
<PAGE>
 
  The effective income tax rate on income (loss) from continuing operations
before income taxes differed from the federal income tax statutory rate for
the following reasons (in thousands):
 
<TABLE>
<CAPTION>
                                                    YEARS ENDED SEPTEMBER 30
                                                    --------------------------
                                                      1997     1996     1995
                                                    --------  -------  -------
   <S>                                              <C>       <C>      <C>
   Tax expense (benefit) at U.S. federal statutory
    rate..........................................  $(47,739) $29,703  $(6,530)
   Increases (reductions) in tax expense (benefit)
    resulting from:
     Purchased research and development for which
      no income tax benefit was recognized........    36,251            21,700
     Taxes on foreign subsidiaries' income at
      rates less than the U.S. federal statutory
      rates.......................................    (1,307)
     Recognition of previously unrecognized
      deferred income tax asset...................    (3,022)  (7,853)  (1,197)
     Amortization and write-down of excess cost
      over net assets acquired....................    14,663    1,680    1,761
     Foreign sales corporation....................    (1,891)  (1,568)  (2,163)
     State income taxes, net of federal benefit...      (125)   2,970      764
     Other........................................      (258)    (644)     665
                                                    --------  -------  -------
                                                    $ (3,428) $24,288  $15,000
                                                    ========  =======  =======
</TABLE>
 
  Income (loss) before income taxes includes foreign pretax earnings (losses)
of $7,269,000, $3,525,000 and $(4,300,000) for the years ended September 30,
1997, 1996 and 1995, 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. Significant components
of the Company's net deferred tax asset as of September 30 are as follows (in
thousands):
 
<TABLE>
<CAPTION>
                                                              1997     1996
                                                             -------  -------
   <S>                                                       <C>      <C>
   Deferred income tax assets:
     Net operating loss carryforwards....................... $35,116  $44,167
     General business and alternative minimum tax credit
      carryforwards.........................................   5,219    5,073
     Foreign tax credit carryforwards.......................            6,583
     Foreign taxes creditable on undistributed foreign
      source income.........................................   5,397    5,397
     Reserves and reorganization accruals...................  59,924   12,640
                                                             -------  -------
       Deferred income tax assets........................... 105,656   73,860
                                                             -------  -------
   Deferred income tax liabilities:
     Capitalized software costs.............................  12,958   11,292
     Depreciation and amortization..........................   2,253    2,110
     Other future income tax liabilities....................  27,491   13,626
                                                             -------  -------
       Deferred income tax liabilities......................  42,702   27,028
                                                             -------  -------
     Deferred income tax asset net of deferred income tax
      liability.............................................  62,954   46,832
     Less valuation allowance............................... (40,824) (43,846)
                                                             -------  -------
       Net deferred income tax asset........................ $22,130  $ 2,986
                                                             =======  =======
</TABLE>
 
  The valuation allowance relates principally to certain net operating loss
and credit carryforwards. Although realization is not assured, management
believes that future taxable income based on expected future earnings of the
Company will more likely than not utilize a portion of the net operating loss
carryforwards, tax credit carryforwards and other future tax deductions in
existence at September 30, 1997, equivalent to the net deferred income tax
asset. As there can be no assurances on amounts in excess of the net deferred
income tax asset, the aforementioned valuation allowance has been recorded and
may change as estimates during the carryforward periods change.
 
                                      40
<PAGE>
 
  At September 30, 1997, the Company had net operating loss and tax credit
carryforwards for federal income tax purposes of approximately $63,750,000 and
$5,220,000, respectively. These carryforwards will expire at various times
between 1998 and 2009, with approximately $63,750,000 of the net operating
loss carryforwards expiring between 2007 and 2009. The utilization of
substantially all of these carryforwards is restricted to future taxable
income of certain of the Company's wholly owned subsidiaries and limited by
Section 382 of the Internal Revenue Code of 1986, as amended (the "Code").
Thus, the Company's utilization of these carryforwards cannot be assured.
 
13. COMMITMENTS
 
  The Company leases certain facilities and equipment under operating leases.
Total rent expense for the years ended September 30, 1997, 1996 and 1995 was
$22,667,000, $19,366,000 and $26,359,000, respectively. At September 30, 1997,
minimum future rental payments due under all operating leases, net of
estimated future sublease income, are as follows (in thousands):
 
<TABLE>
         <S>                                            <C>
         1998.......................................... $ 26,859
         1999..........................................   23,729
         2000..........................................   18,212
         2001..........................................   13,958
         2002..........................................    9,207
         Thereafter....................................   31,923
                                                        --------
                                                        $123,888
                                                        ========
</TABLE>
 
14. PREFERRED STOCK
 
  The Company is authorized to issue up to 10,000,000 shares of preferred
stock, par value $0.10 per share ("Preferred Stock"). The Board of Directors
of Sterling Software has authorized the issuance of up to 750,000 shares of
Preferred Stock, designated as Series A Junior Participating Preferred Stock
("Series A Junior Preferred Stock"), pursuant to the terms of the Rights
Agreement dated as of December 18, 1996 (the "Rights Plan"). The Board of
Directors of the Company is authorized, without action by the stockholders, to
issue Preferred Stock and fix for each series the number of shares,
designation, dividend rights, voting rights, redemption rights and other
rights.
 
15. RIGHTS PLAN
 
  On December 18, 1996, the Board of Directors of the Company declared a
dividend distribution of one right (a "Right") for each share of Common Stock
outstanding at the close of business on December 31, 1996 (the "Record Date"),
pursuant to the terms of the Rights Plan. The Rights Plan also provides,
subject to specified exceptions and limitations, that shares of Common Stock
issued after the Record Date will be entitled to and accompanied by Rights.
Pursuant to the Rights Plan, one Right to purchase 1/100th of a share of
Series A Junior Preferred Stock (structured so as to be substantially the
equivalent of a share of Common Stock) is attached to each issued and
outstanding share of Common Stock. Subject to certain conditions, each Right
entitles the holder to purchase 1/100th of a share of Series A Junior
Preferred Stock at a price (the "Purchase Price") of $200.00 per 1/100th of a
share of Junior Preferred Stock (subject to adjustment).
 
  In general, the Rights will not become exercisable, or transferable apart
from the shares of Common Stock, unless a person or group of affiliated or
associated persons becomes the beneficial owner of, or commences a tender
offer that would result in beneficial ownership of, 15% or more of the
outstanding shares of Common Stock (any such person or group of persons being
referred to in the Rights Plan as an "Acquiring Person"). Thereafter, under
certain circumstances, each Right (other than any Rights that are or were
beneficially owned by an Acquiring Person, which Rights will be void) could
become exercisable to purchase at the Purchase Price a number of shares of
Common Stock (or, in certain circumstances, the common stock of a company into
which the Company is merged or consolidated or to which the Company sells all
or substantially all of its assets) having a market value equal to two times
the Purchase Price. The Rights will expire on December 31, 2006, unless
earlier redeemed by Sterling Software at a redemption price of $.01 per Right
(subject to adjustment), or otherwise exchanged or amended in accordance with
the terms of the Rights Plan.
 
                                      41
<PAGE>
 
16. STOCK OPTIONS AND WARRANTS
 
  In April 1996, Sterling Software's Board of Directors adopted, and in May
1996 Sterling Software's stockholders approved, the 1996 Stock Option Plan. In
September 1996, the 1996 Stock Option Plan was amended to conform to certain
amendments to the rules promulgated under Section 16 of the Securities
Exchange Act of 1934. At September 30, 1997, 485,545 shares were reserved for
future grants of options under the 1996 Stock Option Plan. Options granted
pursuant to the 1996 Stock Option Plan become exercisable generally within 90
days of the date of grant or at a rate of 25% per year and expire either five
or ten years from the date of grant. Any tax benefit associated with the
exercise of options and warrants is credited to paid-in capital. As a result
of the approval of the 1996 Stock Option Plan, Sterling Software's Board of
Directors will not issue any of the remaining 1,293,000 options available for
grant under Sterling Software's other existing stock option plans.
 
  Options that were unexercised with respect to 81,681 shares of Common Stock
at the close of business on September 30, 1996 were adjusted to thereafter be
exercisable with respect to 207,950 shares at exercise prices ranging from
$3.36 to $32.40 to preserve the economic value of such options after the spin-
off of Sterling Commerce. Stock option transactions are summarized below for
the three years ended September 30, 1997:
 
<TABLE>
<CAPTION>
                                    1997                1996                 1995
                             ------------------- -------------------- --------------------
                                        WEIGHTED             WEIGHTED             WEIGHTED
                                        AVERAGE              AVERAGE              AVERAGE
                                        EXERCISE             EXERCISE             EXERCISE
                              OPTIONS    PRICE    OPTIONS     PRICE    OPTIONS     PRICE
                             ---------  -------- ----------  -------- ----------  --------
   <S>                       <C>        <C>      <C>         <C>      <C>         <C>
   Options outstanding at
    October 1..............     81,681   $46.06   8,085,731   $28.36   6,460,763   $19.34
   Conversion adjustment...    126,269
   Options assumed in the
    Merger.................                                              166,173    50.25
   Options granted.........  9,551,900    28.27   1,147,675    42.33   4,886,547    29.79
   Options exercised.......   (104,503)   13.61  (8,912,213)   27.69  (3,242,780)   17.70
   Options terminated and
    canceled...............   (497,193)   26.33    (239,512)   36.26    (184,972)   29.52
                             ---------           ----------           ----------
   Options outstanding at
    September 30...........  9,158,154    28.51      81,681    46.06   8,085,731    28.36
                             =========           ==========           ==========
   Options exercisable at
    September 30...........  4,601,704    28.03      81,681    46.06   3,781,222    30.26
                             =========           ==========           ==========
   Options available for
    grant at September 30..    485,545            7,750,000            1,293,704
                             =========           ==========           ==========
</TABLE>
 
  Information related to options outstanding at September 30, 1997 is
summarized below:
 
<TABLE>
<CAPTION>
                                         OPTIONS OUTSTANDING              OPTIONS EXERCISABLE
                              ----------------------------------------- ------------------------
                                        WEIGHTED AVERAGE    WEIGHTED                 WEIGHTED
                                           REMAINING        AVERAGE                  AVERAGE
   RANGE OF EXERCISE PRICES    OPTIONS  CONTRACTUAL LIFE EXERCISE PRICE  OPTIONS  EXERCISE PRICE
   ------------------------   --------- ---------------- -------------- --------- --------------
   <S>                        <C>       <C>              <C>            <C>       <C>
           $ 3.99--
             $27.25           1,171,118     8 Years          $26.83       573,718     $26.40
           $27.26--
             $28.25           6,790,150     8 Years          $28.25     4,000,000     $28.25
           $28.26--
             $35.50           1,196,886     6 Years          $31.63        27,986     $29.39
                              ---------                                 ---------
                              9,158,154                                 4,601,704
                              =========                                 =========
</TABLE>
 
  During 1996 and 1995, 310,097 and 189,300 warrants with an aggregate
exercise price of $10,734,659 and $4,012,704, respectively, were exercised for
shares of Common Stock. Also, in 1996, 82,650 warrants with an aggregate
exercise price of $8,750,155 were canceled. At September 30, 1997 and 1996, no
warrants were outstanding.
 
                                      42
<PAGE>
 
  FAS 123 requires disclosure of pro forma net earnings and net earnings per
common share information computed as if the Company had accounted for its
employee stock options granted subsequent to October 1, 1995 under the fair
value method set forth in FAS 123. The fair value of the Company's outstanding
stock options was estimated at the date of grant using a Black-Scholes option
pricing model with the following weighted average assumptions.
 
<TABLE>
<CAPTION>
                                                                       YEARS
                                                                       ENDED
                                                                     SEPTEMBER
                                                                        30
                                                                     ----------
                                                                     1997  1996
                                                                     ----  ----
     <S>                                                             <C>   <C>
     Expected option life in years..................................  4.0   4.0
     Risk-free interest rate........................................ 5.74% 6.14%
     Volatility factor.............................................. 0.40  0.40
</TABLE>
 
  The Company does not have a history of paying dividends and none have been
assumed in estimating the fair value of the options.
 
  The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because, among other things, changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the
fair value of its employee stock options. For purposes of pro forma
disclosures, the estimated fair value of the options is amortized to expense
over the options' vesting periods. In addition, because FAS 123 is applicable
only to options granted subsequent to October 1, 1995, the pro forma
information does not reflect the pro forma effect of all previous stock option
grants of the Company. Therefore, the pro forma information is not necessarily
indicative of future amounts until FAS 123 is applied to all outstanding stock
options.
 
<TABLE>
<CAPTION>
                                                              YEARS ENDED
                                                              SEPTEMBER 30
                                                           -------------------
                                                             1997       1996
                                                           ---------  --------
   <S>                                                     <C>        <C>
   Pro forma net income (loss)............................ $(174,180) $226,037
   Pro forma net income (loss) per share:
     Primary.............................................. $   (4.52) $   6.63
     Fully diluted........................................ $   (4.52) $   6.32
   Weighted-average fair value of options granted during
    the year.............................................. $   12.00  $   6.58
</TABLE>
 
17. POSTRETIREMENT BENEFITS
 
  The Company has a plan to provide retirement benefits under the provisions
of Section 401(k) of the Code for full time employees and for part time
employees who have completed a specified term of service. Pursuant to this
plan, eligible participants may elect to contribute a percentage of their
annual gross compensation and the Company will contribute additional amounts,
as provided by the plan. Benefits under the plan are limited to the assets of
the plan. Company contributions charged to expense during 1997, 1996 and 1995
were $2,829,000, $2,315,000 and $2,474,000, respectively. One-half of the
Company's contributions are invested in Common Stock. Effective October 1,
1996, the portion of the plan consisting of the Company's contributions was
designated as an employee stock ownership plan. During 1997, 1996 and 1995,
the investment of the Company's contributions included 19,771, 19,665 and
28,597 shares of Common Stock, respectively. These share contributions include
those made with respect to Sterling Commerce employees through September 30,
1996, the date of the spin-off.
 
  Certain of the Company's subsidiaries also provide healthcare benefits to
eligible retired employees. These benefits are subject to deductibles,
copayment provisions and other limitations including retiree premium
contributions. The Company's policy is to fund the cost of such postretirement
healthcare coverage in amounts determined at the discretion of management. A
plan amendment was adopted in October 1994 that reduced
 
                                      43
<PAGE>
 
the number of employees eligible for participation in the postretirement
benefit plan and reduced the Company's future cost for certain eligible
participants. The impact of the amendment in 1995 was a curtailment gain of
approximately $1,400,000. A plan amendment was adopted in October 1997 that
extended coverage to non-spouse dependents of eligible retirees. This
amendment is not expected to add additional expense or liability to the plan.
The Company and its subsidiaries may amend or change the plan periodically, or
may terminate the plan.
 
  The following table sets forth the computation of accrued postretirement
healthcare benefit costs at September 30 (in thousands):
 
<TABLE>
<CAPTION>
                                                                  1997   1996
                                                                 ------ ------
   <S>                                                           <C>    <C>
   Accumulated postretirement benefit obligation:
     Retirees................................................... $1,122 $  775
     Fully eligible active plan participants....................    930    977
     Other active plan participants.............................  1,141  1,259
                                                                 ------ ------
                                                                  3,193  3,011
     Assets at fair market value................................  1,924  1,766
                                                                 ------ ------
   Projected benefit obligation in excess of assets at fair
    market value................................................  1,269  1,245
   Unrecognized net gain (loss).................................  1,670  1,768
                                                                 ------ ------
     Accrued postretirement benefit cost........................ $2,939 $3,013
                                                                 ====== ======
</TABLE>
 
  The following table presents net periodic postretirement healthcare benefit
costs for the years ended September 30 (in thousands):
 
<TABLE>
<CAPTION>
                                                                YEARS ENDED
                                                               SEPTEMBER 30
                                                             -------------------
                                                             1997   1996   1995
                                                             -----  -----  -----
   <S>                                                       <C>    <C>    <C>
   Service cost............................................. $  86  $  98  $ 108
   Interest cost............................................   221    205    241
   Actual asset return......................................  (159)  (112)   (90)
   Net amortization and deferral............................  (223)  (233)  (208)
                                                             -----  -----  -----
     Net periodic postretirement benefit cost............... $ (75) $ (42) $  51
                                                             =====  =====  =====
</TABLE>
 
  The weighted average discount rate used in determining the accumulated
postretirement benefit obligation was 7.5% at September 30, 1997 and 1996. The
weighted-average annual assumed rate of increase in the per capita cost of
covered benefits ("Healthcare Cost Trend Rate") is 9% for 1998 and is assumed
to decrease gradually to 5% after 8 years and remain at that level thereafter.
The weighted average Healthcare Cost Trend Rate was 9.5% for 1997 and is
assumed to decrease gradually to 5% after 9 years and remain at that level
thereafter.
 
  The Healthcare Cost Trend Rate assumption has a significant effect on the
amounts reported. For example, increasing the assumed Healthcare Cost Trend
Rate by one percentage point in each year would increase the accumulated
postretirement benefit obligation as of September 30, 1997 by $188,400 and the
aggregate of the service cost and interest cost components of net periodic
postretirement benefit cost for 1997 by $12,900.
 
18. CHANGE-IN-CONTROL AND EMPLOYMENT ARRANGEMENTS
 
  As of September 30, 1997, the Company had change-in-control agreements with
18 of its officers providing for payments based on the individual officer's
respective salary, bonus and benefits if there is a change-in-control (as
defined) in the Company and termination of employment occurs. The change-in-
control agreements further provide that the Company will make certain payments
to each officer party thereto to compensate such officer for the economic
effect of such officer's liability to pay excise taxes to the extent that
payments received by
 
                                      44
<PAGE>
 
such officer, pursuant to the change-in-control agreement, stock option
agreements or otherwise, are considered as "contingent on a change in
ownership or control" under Section 280G of the Code (the "Tax Payment").
Additionally, the Company has agreed to make the Tax Payment to one former
officer of the Company with respect to excise taxes determined to be payable
on benefits received by such former officer under a stock option agreement
with the Company. Based on certain assumptions, at September 30, 1997, the
Company's maximum liability for salaries, bonuses, benefits and Tax Payments
under these agreements was estimated to be approximately $44,000,000. The
Company's actual liability, if any, under these agreements will depend on a
number of factors, including the level of salaries, bonuses and benefits being
received by the then covered officers prior to a change-in-control and the
price at which any change-in-control transaction occurs.
 
  As of September 30, 1997, the Company had entered into severance agreements
with 14 of its officers providing for payments based on the individual
officer's respective salary and bonus and continuation of benefits if the
Company terminates the officer's employment. In addition, the Company has
entered into an agreement with one executive officer that provides for an
annual base salary plus agreed-upon bonuses and benefits and converts to a
consulting agreement upon the occurrence of certain events. The Company has
also entered into a consulting agreement with one of its directors that
provides for severance payments based on the director's consulting
compensation upon the occurrence of certain events. At September 30, 1997, the
Company's maximum estimated liability for future salaries, fees, bonuses and
benefits under these agreements was approximately $15,000,000.
 
 
                                      45
<PAGE>
 
19. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
 
  The Company's consolidated operating results for each quarter of 1997 and
1996 are summarized as follows (in thousands, except per share data):
 
<TABLE>
<CAPTION>
                                                THREE MONTHS ENDED
                                    -------------------------------------------
                                    DECEMBER 31 MARCH 31 JUNE 30   SEPTEMBER 30
                                    ----------- -------- --------  ------------
<S>                                 <C>         <C>      <C>       <C>
Year ended September 30, 1997 (1):
  Revenue
    Products.......................   $36,556   $47,579  $ 52,234    $74,065
    Product support................    30,336    29,179    29,106     40,805
    Services.......................    30,249    29,986    32,904     55,979
                                      -------   -------  --------    -------
                                       97,141   106,744   114,244    170,849
  Cost of sales
    Products and product support...    16,554    18,966    17,668     16,595
    Services.......................    26,308    26,056    29,350     48,309
                                      -------   -------  --------    -------
                                       42,862    45,022    47,018     64,904
                                      -------   -------  --------    -------
  Product development and
   enhancement.....................     4,806     5,011     4,532      8,765
  Selling, general and
   administrative..................    40,732    43,560    45,288     67,761
  Reorganization costs.............                       106,037
  Purchased research and
   development.....................                       137,849
  Income (loss) from continuing
   operations......................    12,740    15,324  (185,463)    24,431
  Average common shares
   outstanding.....................    38,439    38,466    38,533     38,549
  Income (loss) per common share:
    Net income (loss):
      Primary......................   $   .33   $   .40  $  (4.81)   $   .62
      Fully diluted................       .33       .40     (4.81)       .61
Year ended September 30, 1996:
  Revenue
    Products.......................   $34,972   $45,932  $ 50,027    $61,533
    Product support................    31,194    31,121    30,397     30,689
    Services.......................    29,819    29,544    30,122     33,821
                                      -------   -------  --------    -------
                                       95,985   106,597   110,546    126,043
  Cost of sales
    Products and product support...    15,154    18,062    17,665     21,320
    Services.......................    26,076    26,520    26,767     30,675
                                      -------   -------  --------    -------
                                       41,230    44,582    44,432     51,995
  Product development and
   enhancement.....................     6,072     5,197     4,618      5,034
  Selling, general and
   administrative..................    38,677    42,606    45,115     48,839
  Income from continuing
   operations......................     9,018    12,776    17,358     21,446
  Income applicable to common
   stockholders....................    21,307   152,018    29,394     35,169
  Average common shares
   outstanding.....................    26,630    29,450    35,758     37,432
  Income per common share:
    Income from continuing
     operations:
      Primary......................   $   .31   $   .40  $    .47    $   .57
      Fully diluted................       .30       .39       .47        .57
    Net income:
      Primary......................   $   .72   $  4.74  $    .80    $   .93
      Fully diluted................       .66      4.42       .80        .93
</TABLE>
 
                                       46
<PAGE>
 
  Information concerning the Company's operations by business segment for each
quarter of 1997, 1996 and 1995 is summarized as follows (in thousands):
 
<TABLE>
<CAPTION>
                                              THREE MONTHS ENDED
                                 ----------------------------------------------
                                 DECEMBER 31 MARCH 31   JUNE 30   SEPTEMBERN 30
                                 ----------- --------  ---------  -------------
<S>                              <C>         <C>       <C>        <C>
Year ended September 30,
 1997(1):
 Revenue:
  Systems Management............  $ 36,950   $ 43,916  $  46,045    $ 57,768
  Applications Management.......    21,952     21,834     22,015      77,141
  Federal Systems...............    27,858     27,954     30,919      35,059
  Corporate and other...........    10,381     13,040     15,265         881
                                  --------   --------  ---------    --------
    Consolidated totals.........  $ 97,141   $106,744  $ 114,244    $170,849
                                  ========   ========  =========    ========
 Operating Profit (Loss):
  Systems Management............  $ 12,889   $ 17,099  $  18,530    $ 22,111
  Applications Management.......     2,224      2,824      3,378      12,416
  Federal Systems...............     2,395      2,303      1,826       2,165
  Reorganization costs..........                        (106,037)
  Purchased research and
   development..................                        (137,849)
  Corporate and other...........    (8,767)    (9,075)    (6,328)     (7,273)
                                  --------   --------  ---------    --------
    Consolidated totals.........  $  8,741   $ 13,151  $(226,480)   $ 29,419
                                  ========   ========  =========    ========
Year ended September 30, 1996:
 Revenue:
  Systems Management............  $ 35,210   $ 40,969  $  42,558    $ 52,067
  Applications Management.......    26,459     28,228     28,244      26,873
  Federal Systems...............    26,262     26,815     27,553      31,558
  Corporate and other...........     8,054     10,585     12,191      15,545
                                  --------   --------  ---------    --------
    Consolidated totals.........  $ 95,985   $106,597  $ 110,546    $126,043
                                  ========   ========  =========    ========
 Operating Profit (Loss):
  Systems Management............  $ 11,625   $ 15,535  $  16,389    $ 22,309
  Applications Management.......     3,859      4,630      6,155       1,764
  Federal Systems...............     2,300      1,816      2,038       1,828
  Corporate and other...........    (7,778)    (7,769)    (8,201)     (5,726)
                                  --------   --------  ---------    --------
    Consolidated totals.........  $ 10,006   $ 14,212  $  16,381    $ 20,175
                                  ========   ========  =========    ========
Year ended September 30, 1995:
 Revenue:
  Systems Management............  $ 33,374   $ 37,287  $  37,821    $ 46,175
  Applications Management.......    20,010     25,347     29,548      32,304
  Federal Systems...............    23,665     24,590     25,372      28,075
  Corporate and other...........     6,547      6,905     10,039       9,252
                                  --------   --------  ---------    --------
    Consolidated totals.........  $ 83,596   $ 94,129  $ 102,780    $115,806
                                  ========   ========  =========    ========
 Operating Profit (Loss):
  Systems Management............  $ 11,136   $ 13,460  $  14,154    $ 16,721
  Applications Management.......     4,491      5,125      5,284       6,420
  Federal Systems...............     1,526      1,867      1,953       1,302
  Reorganization costs..........   (19,512)
  Purchased research and
   development..................   (62,000)
  Corporate and other...........    (6,308)    (5,386)    (5,894)     (5,529)
                                  --------   --------  ---------    --------
    Consolidated totals.........  $(70,667)  $ 15,066  $  15,497    $ 18,914
                                  ========   ========  =========    ========
</TABLE>
--------
(1) On June 30, 1997, Sterling Software completed the acquisition of TI
    Software for approximately $214,774,000 including costs directly related to
    the acquisition. The acquisition was accounted for in accordance with the
    purchase method of accounting and, accordingly, the results of operations
    of TI Software are included in the Company's results of operations from the
    date of acquisition. The 1997 results of operations include $137,849,000 of
    purchased research and development costs, which is the portion of the
    purchase price attributable to in-process research and development and
    which was charged to expense in accordance with the purchase method of
    accounting. The 1997 results of operations also include reorganization
    costs of $106,037,000 primarily related to the reorganization of the
    Company's operations in connection with the acquisition of TI Software and
    the termination of the Company's International Distributor Agreement with
    Sterling Commerce. These reorganization costs also include the write-down
    of certain excess cost over net assets acquired related to the Company's
    federal systems business. The tax benefit related to the purchased research
    and development and reorganization costs was $39,737,000.
 
                                       47
<PAGE>
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
 
  None.
 
                                   PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
 
  Information concerning the directors of the Company is set forth in the
Proxy Statement to be provided to stockholders in connection with the
Company's 1998 Annual Meeting of Stockholders (the "Proxy Statement") under
the heading "Proposal I--Election of Directors," which information is
incorporated herein by reference. Information concerning compliance with
Section 16 of the Securities Exchange Act of 1934, as amended, by persons
subject to such Section is set forth in the Proxy Statement under the heading
"Section 16(a) Beneficial Ownership Reporting Compliance," which information
is incorporated herein by reference. The name, age and position of each
executive officer of the Company is set forth under the heading "Executive
Officers" in Part I of this report, which information is incorporated herein
by reference.
 
ITEM 11. EXECUTIVE COMPENSATION.
 
  Information concerning executive compensation is set forth in the Proxy
Statement under the headings "Management Compensation" and "Proposal I--
Election of Directors," which information is incorporated herein by reference.
Information contained in the Proxy Statement under the caption "Management
Compensation--Report of the Executive and Stock Option Committees on Executive
Compensation" and "--Stock Performance Chart" is not incorporated by reference
herein.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
 
  Information concerning security ownership of certain beneficial owners and
management is set forth in the Proxy Statement under the heading "Security
Ownership of Management and Certain Stockholders," which information is
incorporated herein by reference.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
 
  Information concerning certain relationships and related transactions is set
forth in the Proxy Statement under the headings "Management Compensation--
Executive and Stock Option Committee Interlocks and Insider Participation" and
"Certain Transactions," which information is incorporated herein by reference.
 
                                      48
<PAGE>
 
                                    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 Annual Report on Form
10-K.
 
  1. Consolidated Financial Statements:
 
    See Index to Consolidated Financial Statements at Item 8.
 
  2. Consolidated Financial Statement Schedule:
 
    Schedule II--Valuation and Qualifying Accounts for the Years Ended
  September 30, 1997, 1996 and 1995.
 
  3. Exhibits:
 
<TABLE>
   <C>   <S>
    2.1  Asset Purchase Agreement, dated April 18, 1997, by and between Texas
         Instruments Incorporated and the Company (1)
    2.2  Amendment No. 1 to Asset Purchase Agreement, dated June 19, 1997, by
         and between Texas Instruments Incorporated, the Company and certain
         subsidiaries of the Company, and Amendment No. 2 to Asset Purchase
         Agreement, dated June 28, 1997, by and between Texas Instruments
         Incorporated, the Company and certain subsidiaries of the Company (2)
    3.1  Certificate of Incorporation of the Company, as amended (3)
    3.2  Restated Bylaws of the Company (4)
    4.1  Form of Common Stock Certificate (5)
    4.2  Rights Agreement, dated December 18, 1996, by and between the Company
         and The First National Bank of Boston, as Rights Agent (6)
   10.1  Supplemental Executive Retirement Plan II of Informatics General
         Corporation ("SERP II"), as amended by Amendment to SERP II (7), (8)
   10.2  Sterling Software, Inc. Amended and Restated 1996 Stock Option Plan
         (8), (9)
   10.3  Form of Stock Option Agreement between the Company and each of Sam
         Wyly and Charles J. Wyly, Jr. (8), (19)
   10.4  Form of Stock Option Agreement between the Company and Sterling L.
         Williams (8), (19)
   10.5  Form of Stock Option Agreement between the Company and Jeannette P.
         Meier (8), (19)
   10.6  Form of Stock Option Agreement between the Company and Geno P. Tolari
         (8), (19)
   10.7  1997 Executive Compensation Plan for Group Presidents (8), (11)
   10.8  1998 Executive Compensation Plan for Group Presidents (8), (19)
   10.9  Employment Agreement, dated December 1, 1994, between the Company and
         Werner L. Frank (8), (12)
   10.10 Consulting Agreement, dated October 1, 1996, between the Company and
         Michael C. French (8), (11)
   10.11 Agreement, dated February 12, 1996, between the Company and Sterling
         L. Williams (8), (13)
   10.12 Form of Change-in-Control Severance Agreement, dated February 12,
         1996, between the Company and each of Sam Wyly, Charles J. Wyly, Jr.,
         Sterling L. Williams, Jeannette P. Meier and Geno P. Tolari (8), (13)
   10.13 Form of Amendment to Change-in-Control Severance Agreement, dated June
         18, 1996, between the Company and each of Sam Wyly, Charles J. Wyly,
         Jr., Sterling L. Williams, Jeannette P. Meier and Geno P. Tolari (8),
         (14)
</TABLE>
 
                                       49
<PAGE>
 
<TABLE>
   <C>   <S>
   10.14 Form of Severance Agreement, dated February 12, 1996, between the
         Company and each of Jeannette P. Meier and Geno P. Tolari (8), (13)
   10.15 Form of Amendment to Severance Agreement, dated August 15, 1997,
         between the Company and each of Jeannette P. Meier and Geno P. Tolari
         (8), (19)
   10.16 Form of Indemnity Agreement between the Company and each of its
         directors and officers (7)
   10.17 Sterling Software, Inc. Deferred Compensation Plan (adopted effective
         February 1, 1997) (8), (15)
   10.18 First Amendment to Sterling Software, Inc. Deferred Compensation Plan,
         dated October 27, 1997 (8), (19)
   10.19 Third Amended and Restated Revolving Credit Agreement, dated July 1,
         1997, by and among the Company, BankBoston, N.A. and Bank One, Texas,
         National Association and BankBoston, N.A. as agent for itself and Bank
         One, Texas, National Association (16)
   10.20 Tax Allocation Agreement, dated March 4, 1996, between the Company and
         Sterling Commerce, Inc. (17)
   10.21 Indemnification Agreement, dated March 4, 1996, between the Company
         and Sterling Commerce, Inc. (18)
   10.22 International Distributor Agreement, dated March 4, 1996, between
         Sterling Software International, Inc. and Sterling Commerce
         International, Inc. (18)
   10.23 Amendment No. 1 to International Distributor Agreement, dated January
         31, 1997, between Sterling Commerce B.V. and Sterling Software
         International, Inc. (3)
   10.24 Termination Agreement, dated June 30, 1997, between Sterling Software
         International, Inc. and Sterling Commerce B.V. (2)
   10.25 Master Software License Agreement, dated March 4, 1996, by and among
         the Company, Sterling Commerce, Inc. and their respective subsidiaries
         parties thereto (18)
   10.26 Agreement dated September 19, 1996 by Sterling Commerce, Inc. for the
         benefit of the Company (11)
   11.1  Computation of Earnings Per Share, Year Ended September 30, 1996 (19)
   21.1  Subsidiaries of the Company (19)
   23.1  Consent of Ernst & Young LLP (19)
   27.1  Financial Data Schedule (19)
</TABLE>
--------
 (1) Previously filed as an exhibit to the Company's Quarterly Report on Form
     10-Q for the quarter ended March 31, 1997 and incorporated herein by
     reference. In accordance with Item 601 of Regulation S-K, this copy of
     the Asset Purchase Agreement does not include the schedules or exhibits
     thereto, which schedules and exhibits are listed in the table of contents
     to the Asset Purchase Agreement. The Company agrees to furnish
     supplementary to the Securities and Exchange Commission a copy of such
     schedules and exhibits upon request.
 (2) Previously filed as an exhibit to the Company's Current Report on Form 8-
     K dated June 30, 1997, as amended, and incorporated herein by reference.
 (3) Previously filed as an exhibit to the Company's Quarterly Report on Form
     10-Q for the quarter ended December 31, 1996 and incorporated herein by
     reference.
 (4) Previously filed as an exhibit to the Company's Registration Statement
     No. 33-47131 and incorporated herein by reference.
 (5) Previously filed as an exhibit to the Company's Registration Statement
     No. 2-86825 and incorporated herein by reference.
 (6) Previously filed as an exhibit to the Company's Current Report on Form 8-
     K dated December 18, 1996 and incorporated herein by reference.
 (7) Previously filed as an exhibit to the Company's Annual Report on Form 10-
     K for the fiscal year ended September 30, 1993 and incorporated herein by
     reference.
 
                                      50
<PAGE>
 
 (8) Management contract or compensatory plan or arrangement required to be
     filed as an exhibit to this form pursuant to Item 14(c) of Form 10-K.
 (9) Previously filed as an exhibit to the Company's Registration Statement
     No. 333-13303 and incorporated herein by reference.
(10) Previously filed as an exhibit to the Company's Annual Report on Form 10-
     K for the fiscal year ended September 30, 1995 and incorporated herein by
     reference.
(11) Previously filed as an exhibit to the Company's Annual Report on Form 10-
     K for the fiscal year ended September 30, 1996 and incorporated herein by
     reference.
(12) Previously filed as an exhibit to the Company's Annual Report on Form 10-
     K for the fiscal year ended September 30, 1994 and incorporated herein by
     reference.
(13) Previously filed as an exhibit to the Company's Quarterly Report on Form
     10-Q for the quarter ended March 31, 1996 and incorporated herein by
     reference.
(14) Previously filed as an exhibit to the Company's Quarterly Report on Form
     10-Q for the quarter ended June 30, 1996 and incorporated herein by
     reference.
(15) Previously filed as an exhibit to the Company's Registration Statement
     No. 333-37653 and incorporated herein by reference.
(16) Previously filed as an exhibit to the Company's Quarterly Report on Form
     10-Q for the quarter ended June 30, 1997 and incorporated herein by
     reference.
(17) Previously filed as an exhibit to Registration Statement No. 33-80595
     filed by Sterling Commerce, Inc. and incorporated herein by reference.
(18) Previously filed as an exhibit to the Quarterly Report on Form 10-Q for
     the quarter ended March 31, 1996 filed by Sterling Commerce, Inc. and
     incorporated herein by reference.
(19) Filed herewith.
 
  (b) Reports on Form 8-K.
 
    During the three-month period ended September 30, 1997, the Company filed
  one Current Report on Form 8-K (the "Report"). The Report, dated June 30,
  1997 and filed with the Securities and Exchange Commission on July 1, 1997,
  included information under Item 2--Acquisition or Disposition of Assets and
  Item 5--Other Events. On August 13, 1997, the Report was amended to include
  the financial statements and exhibits required by Item 7 of Form 8-K.
 
                                      51
<PAGE>
 
                                  SIGNATURES
 
  Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
 
                                          STERLING SOFTWARE, INC.
 
Date: November 18, 1997                          /s/ Sterling L. Williams
                                          By: _________________________________
                                              Sterling L. Williams President,
                                                Chief Executive Officer and
                                               Director (Principal Executive
                                                         Officer)
 
Date: November 18, 1997                              /s/ R. Logan Wray
                                          _____________________________________
                                                 R. Logan Wray Senior Vice
                                               President and Chief Financial
                                             Officer (Principal Financial and
                                                    Accounting Officer)
 
                                      52
<PAGE>
 
  Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
 
 
 
Date: November 18, 1997                           /s/ Robert J. Donachie
                                          -------------------------------------
                                                    Robert J. Donachie
                                              Chairman of the Audit Committee
                                                       and Director
 
Date: November 18, 1997                            /s/ Michael C. French
                                          -------------------------------------
                                                     Michael C. French
                                                         Director
 
Date: November 18, 1997                            /s/ Phillip A. Moore
                                          -------------------------------------
                                                     Phillip A. Moore
                                                         Director
 
Date: November 18, 1997                          /s/ Charles J. Wyly, Jr.
                                          -------------------------------------
                                                   Charles J. Wyly, Jr.
                                              Vice Chairman of the Board and
                                                         Director
 
Date: November 18, 1997                              /s/ Evan A. Wyly
                                          -------------------------------------
                                                       Evan A. Wyly
                                                Vice President and Director
 
Date: November 18, 1997                          /s/ Donald R. Miller, Jr.
                                          -------------------------------------
                                                   Donald R. Miller, Jr.
                                                         Director
 
Date: November 18, 1997                            /s/ Alan W. Steelman
                                          -------------------------------------
                                                     Alan W. Steelman
                                                         Director
 
Date: November 18, 1997                          /s/ Sterling L. Williams
                                          -------------------------------------
                                                   Sterling L. Williams
                                            President, Chief Executive Officer
                                                       and Director
                                               (Principal Executive Officer)
 
Date: November 18, 1997                                /s/ Sam Wyly
                                          -------------------------------------
                                                         Sam Wyly
                                            Chairman of the Board and Director
 
                                      53
<PAGE>
 
                                                                    SCHEDULE II
 
                            STERLING SOFTWARE, INC.
                       VALUATION AND QUALIFYING ACCOUNTS
                 YEARS ENDED SEPTEMBER 30, 1997, 1996 AND 1995
 
<TABLE>
<CAPTION>
                                         ADDITIONS
                                   ----------------------
                                              CHARGED TO
                        BALANCE AT CHARGED TO    OTHER                         BALANCE AT
                        BEGINNING  COSTS AND  ACCOUNTS--      DEDUCTIONS--       END OF
                        OF PERIOD   EXPENSES   DESCRIBE         DESCRIBE         PERIOD
                        ---------- ---------- -----------     ------------     -----------
<S>                     <C>        <C>        <C>             <C>              <C>
Allowance for doubtful
 accounts at September
 30, 1995.............. $6,532,000 $4,351,000 $(1,563,000)(1) $(2,144,000)(2)  $ 7,176,000
                        ========== ========== ===========     ===========      ===========
Allowance for doubtful
 accounts at September
 30, 1996.............. $7,176,000 $4,857,000 $(1,998,000)(1) $(3,959,000)(2)  $ 6,076,000
                        ========== ========== ===========     ===========      ===========
Allowance for doubtful
 accounts at September
 30, 1997.............. $6,076,000 $3,950,000 $ 4,436,000 (3) $(2,310,000)(2)  $12,152,000
                        ========== ========== ===========     ===========      ===========
</TABLE>
--------
(1) Offsets to deferred revenue.
(2) Accounts written off.
(3) Offsets to deferred revenue and allowances for doubtful accounts acquired
    in the acquisition of the Software Division of Texas Instruments
    Incorporated.
<PAGE>
 
                               INDEX TO EXHIBITS
 
<TABLE>
<CAPTION>
 EXHIBIT
   NO.                                 DESCRIPTION
 -------                               -----------
 <C>     <S>
  2.1    Asset Purchase Agreement, dated April 18, 1997, by and between Texas
         Instruments Incorporated and the Company (1)
  2.2    Amendment No. 1 to Asset Purchase Agreement, dated June 19, 1997, by
         and between Texas Instruments Incorporated, the Company and certain
         subsidiaries of the Company, and Amendment No. 2 to Asset Purchase
         Agreement, dated June 28, 1997, by and between Texas Instruments
         Incorporated, the Company and certain subsidiaries of the Company (2)
  3.1    Certificate of Incorporation of the Company, as amended (3)
  3.2    Restated Bylaws of the Company (4)
  4.1    Form of Common Stock Certificate (5)
  4.2    Rights Agreement, dated December 18, 1996, by and between the Company
         and The First National Bank of Boston, as Rights Agent (6)
 10.1    Supplemental Executive Retirement Plan II of Informatics General
         Corporation ("SERP II"), as amended by Amendment to SERP II (7), (8)
 10.2    Sterling Software, Inc. Amended and Restated 1996 Stock Option Plan
         (8), (9)
 10.3    Form of Stock Option Agreement between the Company and each of Sam
         Wyly and Charles J. Wyly Jr. (8), (19)
 10.4    Form of Stock Option Agreement between the Company and Sterling L.
         Williams (8), (19)
 10.5    Form of Stock Option Agreement between the Company and Jeannette P.
         Meier (8), (19)
 10.6    Form of Stock Option Agreement between the Company and Geno P. Tolari
         (8), (19)
 10.7    1997 Executive Compensation Plan for Group Presidents (8), (11)
 10.8    1998 Executive Compensation Plan for Group Presidents (8), (19)
 10.9    Employment Agreement, dated December 1, 1994 between the Company and
         Werner L. Frank (8), (12)
 10.10   Consulting Agreement, dated October 1, 1996, between the Company and
         Michael C. French (8), (11)
 10.11   Agreement, dated February 12, 1996, between the Company and Sterling
         L. Williams (8), (13)
 10.12   Form of Change-in-Control Severance Agreement, dated February 12,
         1996, between the Company and each of Sam Wyly, Charles J. Wyly, Jr.,
         Sterling L. Williams, Jeannette P. Meier and Geno P. Tolari (8), (13)
 10.13   Form of Amendment to Change-in-Control Severance Agreement, dated June
         18, 1996, between the Company and each of Sam Wyly, Charles J. Wyly,
         Jr., Sterling L. Williams, Jeannette P. Meier and Geno P. Tolari (8),
         (14)
 10.14   Form of Severance Agreement, dated February 12, 1996, between the
         Company and each of Jeannette P. Meier and Geno P. Tolari (8), (13)
 10.15   Form of Amendment to Severance Agreement, dated August 15, 1997,
         between the Company and each of Jeannette P. Meier and Geno P. Tolari
         (8), (19)
 10.16   Form of Indemnity Agreement between the Company and each of its
         directors and officers (7)
 10.17   Sterling Software, Inc. Deferred Compensation Plan (adopted effective
         February 1, 1997) (8), (15)
 10.18   First Amendment to Sterling Software, Inc. Deferred Compensation Plan,
         dated October 27, 1997 (8), (19)
</TABLE>
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT
   NO.                                 DESCRIPTION
 -------                               -----------
 <C>     <S>
 10.19   Third Amended and Restated Revolving Credit Agreement, dated July 1,
         1997, by and among the Company, BankBoston, N.A. and Bank One, Texas,
         National Association and BankBoston, N.A. as agent for itself and Bank
         One, Texas, National Association (16)
 10.20   Tax Allocation Agreement, dated March 4, 1996, between the Company and
         Sterling Commerce, Inc. (17)
 10.21   Indemnification Agreement, dated March 4, 1996, between the Company
         and Sterling Commerce, Inc. (18)
 10.22   International Distributor Agreement, dated March 4, 1996, between
         Sterling Software International, Inc. and Sterling Commerce
         International, Inc. (18)
 10.23   Amendment No. 1 to International Distributor Agreement, dated January
         31, 1997, between Sterling Commerce B.V. and Sterling Software
         International, Inc. (3)
 10.24   Termination Agreement, dated June 30, 1997, between Sterling Software
         International, Inc. and Sterling Commerce B.V. (2)
 10.25   Master Software License Agreement, dated March 4, 1996, by and among
         the Company, Sterling Commerce, Inc. and their respective subsidiaries
         parties thereto (18)
 10.26   Agreement dated September 19, 1996 by Sterling Commerce, Inc. for the
         benefit of the Company (11)
 11.1    Computation of Earnings Per Share, Year Ended September 30, 1996 (19)
 21.1    Subsidiaries of the Company (19)
 23.1    Consent of Ernst & Young LLP (19)
 27.1    Financial Data Schedule (19)
</TABLE>
--------
 (1) Previously filed as an exhibit to the Company's Quarterly Report on Form
     10-Q for the quarter ended March 31, 1997 and incorporated herein by
     reference. In accordance with Item 601 of Regulation S-K, this copy of
     the Asset Purchase Agreement does not include the schedules or exhibits
     thereto, which schedules and exhibits are listed in the table of contents
     to the Asset Purchase Agreement. The Company agrees to furnish
     supplementary to the Securities and Exchange Commission a copy of such
     schedules and exhibits upon request.
 (2) Previously filed as an exhibit to the Company's Current Report on Form 8-
     K dated June 30, 1997, as amended, and incorporated herein by reference.
 (3) Previously filed as an exhibit to the Company's Quarterly Report on Form
     10-Q for the quarter ended December 31, 1996 and incorporated herein by
     reference.
 (4) Previously filed as an exhibit to the Company's Registration Statement
     No. 33-47131 and incorporated herein by reference.
 (5) Previously filed as an exhibit to the Company's Registration Statement
     No. 2-86825 and incorporated herein by reference.
 (6) Previously filed as an exhibit to the Company's Current Report on Form 8-
     K dated December 18, 1996 and incorporated herein by reference.
 (7) Previously filed as an exhibit to the Company's Annual Report on Form 10-
     K for the fiscal year ended September 30, 1993 and incorporated herein by
     reference.
 (8) Management contract or compensatory plan or arrangement required to be
     filed as an exhibit to this form pursuant to Item 14(c) of Form 10-K.
 (9) Previously filed as an exhibit to the Company's Registration Statement
     No. 333-13303 and incorporated herein by reference.
(10) Previously filed as an exhibit to the Company's Annual Report on Form 10-
     K for the fiscal year ended September 30, 1995 and incorporated herein by
     reference.
(11) Previously filed as an exhibit to the Company's Annual Report on Form 10-
     K for the fiscal year ended September 30, 1996 and incorporated herein by
     reference.
<PAGE>
 
(12) Previously filed as an exhibit to the Company's Annual Report on Form 10-
     K for the fiscal year ended September 30, 1994 and incorporated herein by
     reference.
(13) Previously filed as an exhibit to the Company's Quarterly Report on Form
     10-Q for the quarter ended March 31, 1996 and incorporated herein by
     reference.
(14) Previously filed as an exhibit to the Company's Quarterly Report on Form
     10-Q for the quarter ended June 30, 1996 and incorporated herein by
     reference.
(15) Previously filed as an exhibit to the Company's Registration Statement
     No. 333-37653 and incorporated herein by reference.
(16) Previously filed as an exhibit to the Company's Quarterly Report on Form
     10-Q for the quarter ended June 30 , 1997 and incorporated herein by
     reference.
(17) Previously filed as an exhibit to Registration Statement No. 33-80595
     filed by Sterling Commerce, Inc. and incorporated herein by reference.
(18) Previously filed as an exhibit to the Quarterly Report on Form 10-Q for
     the quarter ended March 31, 1996 filed by Sterling Commerce, Inc. and
     incorporated herein by reference.
(19) Filed herewith.