Costs and Expenses

Cost of Software Distribution. Cost of software distribution consists primarily of: (1) manufacturing and related costs such as media, documentation, product assembly and purchasing costs, freight, customs and third party royalties; and (2) amortization of previously capitalized software development costs and any write-offs of previously capitalized software. Cost of software distribution increased $7.7 million, or 22%, to $43.1 million for 1999 compared to $35.4 million for 1998. This increase was primarily due to an increase in royalties related to new products and the write-off of capitalized software costs. During the third quarter of 1999, approximately $2.4 million of previously capitalized software costs were written down to the estimated net realizable value after it was determined that the projected sales of certain tools products and system management programs were not sufficient to realize the capitalized product development costs. Amortization of capitalized software remained relatively flat at $19.3 million in 1999 compared to $20.7 million and $21.4 million in 1998 and 1997, respectively. The amortization of capitalized software will vary from period to period as new products are released and other products become fully amortized. Cost of software distribution decreased to $35.4 million in 1998 from $63.0 million in 1997. This decrease was primarily caused by a write-down in 1997 of $14.7 million to net realizable value of certain of our database tool products related to our acquisition of CenterView Software, Inc. in the first quarter of 1997, a decrease in third party software royalties, the write-off of certain unused application software in the second quarter of 1997 and a reduction in labor, materials and shipping costs.

Cost of Services. Cost of services consists primarily of maintenance, consulting and training expenses. Cost of services for 1999 increased 11% to $173.7 million from $155.9 million in 1998 due primarily to a 10% increase in average headcount during 1999, a portion of which resulted from the addition of the Red Brick consulting team subsequent to the completion of the acquisition in December 1998. Cost of services decreased as a percentage of net service revenues to 41% for 1999 compared to 44% for 1998. The increase in gross service margins from 56% in 1998 to 59% during 1999 was due to a higher percentage of customer maintenance support revenue in 1999 which typically has a higher profit margin than consulting and training services revenue. Maintenance represented approximately 76% of service revenues in 1999 compared to 72% in 1998. Cost of services for 1998 decreased by 7% to $155.9 million as compared to $166.9 million in 1997 and decreased as a percentage of net service revenues to 44% for 1998 compared to 58% for 1997. These decreases were primarily attributable to decreases of 11% in average headcount for 1998 over the same period in 1997 as well as improved efficiency and better control of outsourced expenses.

Sales and Marketing Expenses. Sales and marketing expenses consist primarily of salaries, commissions, marketing and communications programs and related overhead costs. Sales and marketing expenses increased 15% to $312.1 million for 1999 from $271.9 million for 1998 due primarily to increased advertising and marketing efforts during 1999 in connection with the introduction of several new products and our new corporate logo and identity in order to increase brand awareness. This increase was in line with net revenue growth rates as sales and marketing expenses, as a percentage of net revenues, were 36% and 37% for 1999 and 1998, respectively. Sales and marketing expenses decreased 35% to $271.9 million for 1998 from $418.1 million for 1997. The decrease in sales and marketing expenses in 1998 as compared to 1997 was primarily the result of a significant reduction in average sales and marketing headcount worldwide. We intend to invest more resources in marketing and communications programs during 2000 than we have in recent years in order to attempt to create greater market awareness and visibility.