BMC SOFTWARE INC - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(MARK ONE)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

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 NUMBER 0-17136

BMC SOFTWARE, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 74-2126120
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)

BMC SOFTWARE, INC.
2101 CITYWEST BOULEVARD
HOUSTON, TEXAS 77042-2827
(Address of principal executive offices) (Zip Code)

Registrant's telephone number including area code: (713) 918-8800

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 [ ]

As of August 8, 2002, there were outstanding 241,100,942 shares of Common
Stock, par value $.01, of the registrant.

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BMC SOFTWARE, INC. AND SUBSIDIARIES
QUARTER ENDED JUNE 30, 2002

INDEX

2

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

BMC SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)

The accompanying notes are an integral part of these condensed consolidated
financial statements.

3

BMC SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
(IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)

The accompanying notes are an integral part of these condensed consolidated
financial statements.

4

BMC SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)

The accompanying notes are an integral part of these condensed consolidated
financial statements.

5

BMC SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(1) BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements include the
accounts of BMC Software, Inc. and its wholly owned subsidiaries (collectively,
the Company or BMC). All significant intercompany balances and transactions have
been eliminated in consolidation. Certain amounts previously reported have been
reclassified to provide comparability among the periods presented.

The accompanying unaudited interim condensed consolidated financial
statements reflect all normal recurring adjustments which, in the opinion of
management, are necessary for a fair presentation of the results for the periods
presented. These financial statements have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.

These financial statements should be read in conjunction with the Company's
audited financial statements for the year ended March 31, 2002, as filed with
the Securities and Exchange Commission on Form 10-K.

(2) EARNINGS (LOSS) PER SHARE

Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per
Share," requires dual presentation of basic and diluted earnings per share
(EPS). Basic EPS is computed by dividing net earnings (loss) by the weighted
average number of common shares outstanding for the period. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock. For purposes
of this calculation, outstanding stock options and unearned restricted stock are
considered potential common shares using the treasury stock method. For each of
the three months ended June 30, 2001 and 2002, the treasury stock method effect
of 37.2 million weighted options, has been excluded from the calculation of
diluted EPS as they are antidilutive. For the three months ended June 30, 2001
and 2002, the treasury stock method effect of 0.7 million and -- weighted
unearned restricted shares, respectively, has also been excluded, as they are
antidilutive. The following table summarizes the basic and diluted EPS
computations for the three months ended June 30, 2001 and 2002:

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(3) SEGMENT REPORTING

In the quarter ended June 30, 2002, BMC's management began reviewing the
results of the Company's software business by the following product categories:
Enterprise Data Management Software, including the Mainframe Data Management and
Distributed Systems Data Management product lines, Enterprise Systems Management
Software, which includes the PATROL, MAINVIEW and Scheduling & Output Management
product lines, and Other Software, which includes the High Potential product
lines of Storage Management, Security Management, Enterprise Application
Management, Subscription Services and Linux, and other. In addition to these
software segments, the professional services business is also considered a
separate segment. Through March 31, 2002. BMC's management reviewed the results
of the Company's software business by different product categories. The amounts
reported below for the quarters ended June 30, 2001 and 2002, reflect this
change in the composition of the segments.

Segment performance is measured based on contribution margins, which
reflect only the direct controllable expenses of the segments and do not include
allocation of indirect research and development (R&D) expenses, the effect of
software development cost capitalization and amortization, selling and marketing
expenses, general and administrative expenses, amortization of acquired
technology, goodwill and intangibles, one-time charges, other income, net, and
income taxes. Assets and liabilities are not accounted for by segment.

7

(4) RESTRUCTURING AND SEVERANCE COSTS

During the year ended March 31, 2002, BMC implemented a restructuring plan
to better align the Company's cost structure with existing market conditions.
The Company also discontinued certain business information integration products
as a result of the dissolution of that business unit, and announced the closure
of certain locations throughout the world. See the discussion of this plan in
the Company's Annual Report on Form 10-K for the year ended March 31, 2002.

As of June 30, 2002, $1.8 million of severance and facilities costs related
to actions completed under the restructuring plan remained accrued for payment
in future periods.

(5) STOCK INCENTIVE PLANS

The Company has adopted numerous stock compensation plans that provide for
the grant of options and restricted stock to employees and directors of the
Company. All options under these plans vest over terms of three to five years.
The restricted stock is subject to transfer restrictions that lapse over one to
four years.

The Company's accounting for stock options is in accordance with APB
Opinion No. 25 and related interpretations, which generally require that the
amount of compensation cost that must be recognized, if any, is the quoted
market price of the stock at the measurement date, less the amount the grantee
is required to pay to acquire the stock. Alternatively, SFAS No. 123,
"Accounting for Stock-Based Compensation," employs fair value-based measurement
and generally results in the recognition of compensation for all stock-based
awards to employees. SFAS No. 123 does not require an entity to adopt those
provisions, but rather, permits continued application of APB Opinion No. 25. The
Company has elected not to adopt the recognition and measurement provisions of
SFAS No. 123 and continues to account for its employee stock-based compensation
plans under APB Opinion No. 25 and related interpretations. In accordance with
APB Opinion No. 25, deferred compensation is recorded for stock-based
compensation grants based on the excess of the market value of the common stock
on the measurement date over the exercise price. The deferred compensation is
amortized to expense over the vesting period of each unit of stock-based
compensation granted. If the exercise price of the stock-based compensation is
equal to or exceeds the market price of the Company's stock on the date of
grant, no compensation expense is recorded.

For the three months ended June 30, 2001 and 2002, the Company recorded
compensation expense of $4.2 million and $1.3 million, respectively, for
restricted stock grants. The expense for the three months ended June 30, 2001
and 2002, includes $3.1 million and $0.6 million, respectively, of
merger-related compensation charges related to restricted shares issued as part
of the Evity acquisition. The Company was not required to record compensation
expense for stock option grants and stock issued under the employee stock
purchase plan during the same periods.

Had compensation cost for the stock-based compensation plans been
determined based on the grant date fair values of award, which is the method
described in SFAS No. 123), the Company's reported net earnings (loss) and
earnings (loss) per share would have been reduced to the proforma amounts
shown below:

In computing the above pro forma amounts, the fair values of each option
grant and each purchase right under the purchase plan are estimated using the
Black-Scholes option pricing model with the following weighted average
assumptions used for grants in the first quarter of fiscal 2002 and 2003,
respectively: risk-free interest rate of 4.55% and 3.41%, expected life of 5
years for options and 6 months for purchase plan shares, expected volatility of
75% and no expected dividend yields.

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(6) GOODWILL AND INTANGIBLE ASSETS

As of April 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 142 addresses financial accounting and reporting at
the point of acquisition for intangible assets acquired individually or with a
group of other assets, other than those acquired in a business combination, and
the financial accounting and reporting for goodwill and other intangible assets
subsequent to their acquisition. Under this Statement, all goodwill and those
intangible assets with indefinite useful lives are not amortized, but rather are
tested for impairment annually and when events and circumstances indicate that
their fair value has been reduced below carrying value. Intangible assets with
finite useful lives are amortized over those useful lives. We are in the process
of determining the impairment charge, if any, that is required upon adoption of
this Statement. If such a charge is required, it will be reflected as the effect
of a change in accounting principle in the consolidated statement of operations
and comprehensive loss for the quarter ended June 30, 2002.

The following reconciles the Company's reported net earnings (loss) and
earnings (loss) per share to those amounts that would have resulted had goodwill
and intangible assets been accounted for under SFAS No. 142 for all periods
presented:

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION

This section of the Form 10-Q contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, which are
identified by the use of the words "believe," "expect," "anticipate," "will,"
"contemplate," "would" and similar expressions that contemplate future events.
Numerous important factors, risks and uncertainties affect our operating
results, including, without limitation, those contained in this report, and
could cause our actual results to differ materially from the results implied by
these or any other forward-looking statements made by us or on our behalf. There
can be no assurance that future results will meet expectations. You should pay
particular attention to the important risk factors and cautionary statements
described in the section of this Report entitled "Certain Risks and
Uncertainties." It is important that the historical discussion below be read
together with the attached condensed consolidated financial statements and notes
thereto, with the discussion of such risks and uncertainties and with the
audited financial statements and notes thereto, and Management's Discussion and
Analysis of Results of Operations and Financial Condition contained in our Form
10-K for fiscal 2002.

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CRITICAL ACCOUNTING POLICIES

The preparation of condensed consolidated financial statements requires us
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses. On an on-going basis, we evaluate estimates
and judgments, including those related to revenue recognition, capitalized
software development costs, intangible assets, deferred tax assets and
marketable securities. We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
amounts and timing of revenues and expenses, the carrying values of assets and
the recorded amounts of liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates and such estimates may
change if the underlying conditions or assumptions change. The critical
accounting policies related to the estimates and judgments listed above are
discussed further throughout our Form 10-K for fiscal 2002 under Management's
Discussion and Analysis of Results of Operations and Financial Condition where
such policies affect our reported and expected financial results.

A. RESULTS OF OPERATIONS AND FINANCIAL CONDITION

The following table sets forth, for the periods indicated, the percentages
that selected items in the Condensed Consolidated Statements of Operations and
Comprehensive Loss bear to total revenues. These comparisons of financial
results are not necessarily indicative of future results.

10

REVENUES

We recognize revenue in accordance with the American Institute of Certified
Public Accountants (AICPA) Statement of Position ("SOP") 97-2, "Software Revenue
Recognition," and SOP 98-9 "Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions." Based on our reading and
interpretation of these SOPs, we believe that our current sales contract terms
and business arrangements have been properly reported. However, the AICPA and
its Software Revenue Recognition Task Force continue to issue interpretations
and guidance for applying the relevant standards to a wide range of sales
contract terms and business arrangements that are prevalent in the software
industry. Also, the Securities and Exchange Commission (SEC) has issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements,"
which provides guidance related to revenue recognition based on interpretations
and practices followed by the SEC. Future interpretations of existing accounting
standards or changes in our business practices could result in future changes in
our revenue accounting policies that could have a material adverse effect on our
business, financial condition and results of operations. For a more detailed
discussion of our revenue recognition policies, see the footnotes to the
consolidated financial statements included in our Annual Report on Form 10-K for
the year ended March 31, 2002.

Product License Revenues

Our product license revenues primarily consist of product license fees and
license upgrade fees, both of which are related to products licensed to
customers on a perpetual basis. Product license fees are all fees associated
with a customer's licensing of a given software product for the first time.
License upgrade fees are all fees associated with a customer's purchase of the
right to run a previously licensed product on a larger computer or additional
computers. License upgrade fees are primarily generated by our mainframe
products and include fees associated with both current and future additional
processing capacity. In addition to product license fees and license upgrade
fees, license revenues also include, to a lesser extent, term license fees which
are generated when customers are granted license rights to a given software
product for a limited period of time.

Difficult economic conditions in domestic and international markets have
continued to result in reduced IT spending by many of our customers. Tighter
budgets have caused many customers to choose smaller transactions in terms of
dollar value. In addition, there was a significant increase in transactions
where the terms and conditions within our contracts resulted in the deferral of
license revenue. We executed a large domestic transaction in the first quarter
of fiscal 2003 in which almost all the license revenue was deferred to later
periods. This transaction accounted for approximately one-half of the gross
contract license deferrals in the quarter. As of March 31, 2002 and June 30,
2002, our total deferred license revenue balance was $168.9 million and $215.3
million, respectively.

Our North American operations generated 63% and 64% of license revenues in
the three months ended June 30, 2001 and 2002, respectively. The 23% decline in
North American license revenues in the first quarter of fiscal 2003 is mostly
attributed to the trend towards smaller transaction sizes, particularly in the
Enterprise Data Management segment.

11

International license revenues represented 37% and 36% of total license
revenues for the quarters ended June 30, 2001 and 2002, respectively.
International license revenues declined 28% from the first quarter of fiscal
2002, primarily due to weakening demand in Europe and a greater demand for
term-based licenses, which, in general, are deferred and recognized evenly over
the license period.

Maintenance, Enhancement and Support Revenues

Maintenance, enhancement and support revenues represent the ratable
recognition of fees to enroll licensed products in our software maintenance,
enhancement and support program. Maintenance, enhancement and support enrollment
entitles customers to product enhancements, technical support services and
ongoing compatibility with third-party operating systems, database management
systems, networks, storage systems and applications. These fees are generally
charged annually and have historically equaled 15% to 20% of the discounted
price of the product. During the fourth quarter of fiscal 2002, we revised our
maintenance program to a single maintenance offering of 24x7 support with a
standard rate of 20% of the discounted price of the associated product.
Customers may be entitled to reduced maintenance percentages for entering into
long-term maintenance contracts that include prepayment of the maintenance fees
or that are supported by a formal financing arrangement. Maintenance revenues
also include the ratable recognition of the bundled fees for any initial
maintenance services covered by the related perpetual license agreement.

Maintenance revenues increased 7.5% for the three months ended June 30, 2002
over the comparable prior year period as a result of the continuing growth in
the base of installed products and the processing capacity on which they run.
Maintenance fees increase in proportion to the aggregate processing capacity on
which the products are installed; consequently, we receive higher absolute
maintenance fees as customers install our products on additional processing
capacity. Due to the increased discounting for higher levels of additional
processing capacity, the maintenance fees on a per unit of capacity basis are
typically reduced in enterprise license agreements. Our maintenance revenues
have continued to grow, but at a slower rate due to the continued decline in our
license revenues. Historically, we have enjoyed high maintenance renewal rates
for our mainframe-based products. Should customers migrate from their mainframe
applications or find alternatives to our products, increased cancellations could
adversely impact the sustainability and growth of our maintenance revenues. To
date, we have been successful in extending our traditional maintenance and
support pricing model to the distributed systems market.

Product Line Revenues

We market software solutions designed to improve the availability,
performance and recoverability of enterprise applications, databases and other
IT systems components operating in mainframe, distributed computing and Internet
environments. Our solutions are broadly divided into two core business units and
a third business unit geared towards future high potential solution areas. The
Enterprise Data Management group includes products designed for managing
database management systems on mainframe and distributed computing platforms.
The Enterprise Systems Management group includes our scheduling, output
management, and systems management and monitoring solutions. Our objective for
both the Enterprise Data Management and Enterprise Systems Management groups is
to extend our core strengths in these markets. The High Potential product lines
encompass storage management, security, subscription services, enterprise
application management, and Linux management. Our objective for this group is to
develop our business in fast-growing markets.

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Our Enterprise Data Management solutions combined represented 51% and 48% of
total software revenues for the quarters ended June 30, 2001 and 2002,
respectively. Total software revenues for this group declined 16% in the first
quarter of fiscal 2003 from the same period in fiscal 2002. The decrease in
mainframe data management solutions is attributed to smaller dollar transaction
sizes and to the deferral of the large domestic transaction noted above.

Our Enterprise Systems Management solutions combined contributed 42% and 44%
of total software revenues for the quarters ended June 30, 2001 and 2002,
respectively. Total software revenues for this group declined 6% in the first
quarter of fiscal 2003 from the same period in fiscal 2002 primarily due to the
continued weakness in IT spending and a reduction in Unix shipments from
hardware manufacturers such as Sun Microsystems, Hewlett-Packard, and IBM.

Our High Potential product lines contributed 6% and 8% of total software
revenues for the quarters ended June 30, 2001 and 2002, respectively. Total
software revenues for this group grew 12% in the first quarter of fiscal 2003
from the same period in fiscal 2002. This growth includes increases in license
and maintenance revenues from our storage and security solutions.

Professional Services Revenues

Professional services revenues, representing fees from implementation,
integration and education services performed during the period, decreased 10%
during the three months ended June 30, 2002, over the comparable prior year
period. This decline is the result of the decline in our software license
revenue, especially within the PATROL product line, as this results in less
demand for our implementation and integration services. Our professional
services headcount has decreased to accommodate the lower license revenue
levels.

EXPENSES

Selling and Marketing

Our selling and marketing expenses primarily include personnel and related
costs, sales commissions, and costs associated with advertising, industry trade
shows and sales seminars. Selling and marketing expenses decreased 22% in the
first quarter of fiscal 2003 over the same period in fiscal 2002. Contributing
to the decline in selling and marketing expenses were decreases in sales
commissions, bad debt expense related to license billings, personnel related
costs and travel and entertainment costs.

13

Research and Development

Research and development expenses mainly comprise personnel costs related to
software developers and development support personnel, including software
programmers, testing and quality assurance personnel and writers of technical
documentation such as product manuals and installation guides. These expenses
also include costs associated with the maintenance, enhancement and support of
our products, computer hardware/software costs and telecommunications expenses
necessary to maintain our data processing center, royalties and the effect of
software development cost capitalization and amortization. Research and
development costs are reduced by amounts capitalized in accordance with SFAS No.
86, "Accounting for the Costs of Computer Software to Be Sold, Leased or
Otherwise Marketed." We capitalize our software development costs when the
projects under development reach technological feasibility as defined by SFAS
No. 86, and amortize these costs over the products' estimated useful lives.
During the first quarters of fiscal 2002 and 2003, we capitalized approximately
$35.3 million and $17.5 million, respectively, of software development and
purchased software costs. The decrease in capitalized costs is primarily due to
a reduction in the number of current development projects which qualify for
capitalization under SFAS No. 86. We amortized $22.4 million and $22.7 million
in the first quarters of fiscal 2002 and 2003, respectively, of capitalized
software development and purchased software costs pursuant to SFAS No. 86,
including $8.5 million and $10.5 million in the first quarters of fiscal 2002
and 2003, respectively, to accelerate the amortization of certain software
products. We accelerated the amortization of these software products as they
were not expected to generate sufficient future revenues to realize the carrying
value of the assets.

Research and development expenses increased 5% during the first quarter of
fiscal 2003 compared to the same period in fiscal 2002. Lower personnel related
costs were offset by an increase in the net expense effect of software
development cost capitalization and amortization.

Cost of Professional Services

Cost of professional services consists primarily of personnel costs
associated with implementation, integration and education services that we
perform for our customers, and the related infrastructure to support this
business. The decrease in these costs in the three months ended June 30, 2002,
over the comparable prior year period, resulted from the 10% professional
services revenue decline and related headcount reductions, particularly within
the PATROL solutions, combined with lower consulting fees.

General and Administrative

General and administrative expenses are comprised primarily of compensation
and personnel costs within executive management, finance and accounting,
facilities management and human resources. Other costs included in general and
administrative expenses are fees paid for legal and accounting services,
consulting projects, insurance, costs of managing our foreign currency exposure
and bad debt expense related to maintenance billings. The decline in general and
administrative expenses for the three months ended June 30, 2002 over the same
period in the prior year was primarily attributable to decreased bad debt
expense, offset slightly by higher depreciation expense.

Amortization of Acquired Technology, Goodwill and Intangibles

Under the purchase accounting method for certain of our acquisitions,
portions of the purchase prices were allocated to goodwill, customer base,
software and other intangible assets. We are amortizing these intangibles over
three to five-year periods, which reflect the estimated useful lives of the
respective assets. As of April 1, 2002, we adopted SFAS No. 142, "Goodwill and
Other Intangible Assets." Under this pronouncement, goodwill and those
intangible assets with indefinite lives are no longer amortized, but rather are
tested for impairment annually and when events or circumstances indicate that
their fair value has been reduced below carrying value. Acquired technology
continues to be amortized under SFAS No. 86. As a result of our adoption of SFAS
No. 142, the amortization of acquired technology, goodwill and intangibles
expense declined by approximately $36 million from the amount recorded in the
first quarter of fiscal 2002. See Note 6 to the Condensed Consolidated Financial
Statements contained herein for a reconciliation of our reported net earnings
(loss) and earnings (loss) per share to those amounts that would have resulted
had goodwill and intangible assets been accounted for under SFAS No. 142 for all
periods presented.

14

Restructuring and Severance Costs

During the quarter ended June 30, 2001, we terminated approximately 6% of
our workforce worldwide. The action was across all divisions and geographies and
affected employees received cash severance packages, the vast majority of which
were paid during the quarter ended June 30, 2001. The affected employees were
also given the option to receive outplacement services and continued health
benefits for a specified period after termination. A charge of $12.0 million was
recorded during the quarter ended June 30, 2001 for such severance and related
expenses.

Merger-Related Costs and Compensation Charges

In conjunction with our merger with Boole & Babbage, Inc. in March 1999,
management approved a formal plan of restructuring which included steps to be
taken to integrate the operations of the two companies, consolidate duplicate
facilities and streamline operations to achieve reductions in overhead expenses
in future periods. No charges related to this restructuring plan were recorded
during the quarters ended June 30, 2001 and 2002, and as of June 30, 2002, we
have remaining accrued facilities costs of approximately $0.3 million.

During the quarters ended June 30, 2001 and 2002, we recorded compensation
charges of $2.7 million and $0.6 million, respectively, primarily related to the
vesting of common stock issued as part of the Evity acquisition to certain Evity
employee shareholders who we employed after the acquisition.

OTHER INCOME, NET

For the first quarter of fiscal 2003, other income, net was $9.5 million,
reflecting an increase of 10% from $8.6 million in the same quarter of fiscal
2002. Other income, net consists primarily of interest earned on cash, cash
equivalents and marketable securities, gains and losses on marketable securities
and interest expense on short-term borrowings. The increase in other income, net
is primarily due to a $1.1 million reduction of losses on marketable securities
and elimination of interest expense on short-term borrowings which were paid off
in the quarter ended June 30, 2001. In the first quarters ended June 30, 2001
and June 30, 2002, we wrote off $7.4 million and $6.3 million, respectively, of
marketable securities.

INCOME TAX (BENEFIT) PROVISION

For the three months ended June 30, 2002, income tax expense was $1.5
million, compared to a benefit of $13.4 million for the same period in fiscal
2002. Our effective tax rate was 22% for the three months ended June 30, 2002
and 28% for the comparable prior year period.

15

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 addresses financial accounting and reporting for business
combinations and requires that all business combinations be accounted for using
one method, the purchase method. The Statement applies to all business
combinations initiated after June 30, 2001. SFAS No. 142 addresses financial
accounting and reporting at the point of acquisition for intangible assets
acquired individually or with a group of other assets, other than those acquired
in a business combination, and the financial accounting and reporting for
goodwill and other intangible assets subsequent to their acquisition. Under this
Statement, all goodwill and those intangible assets with indefinite useful lives
will no longer be amortized, but rather will be tested for impairment annually
and when events or circumstances indicate that their fair value has been reduced
below carrying value. Intangible assets with finite useful lives will continue
to be amortized over those useful lives. As of April 1, 2002, we have adopted
SFAS No. 141 and SFAS No. 142. The primary impact of adoption is the elimination
of amortization expense related to our goodwill and intangible assets with
indefinite lives from our Consolidated Statement of Operations and Comprehensive
Loss. See Note 6 to the Condensed Consolidated Financial Statements contained
herein for a reconciliation of our reported net earnings (loss) and earnings
(loss) per share to those amounts that would have resulted had goodwill and
intangible assets been accounted for under SFAS No. 142 for all periods
presented. We are in the process of determining the impairment charge, if any,
that will be required upon adoption of SFAS No. 142. If such a charge is
required, it will be reflected as the effect of a change in accounting principle
in the Consolidated Statement of Operations and Comprehensive Loss for the
quarter ended June 30, 2002.

In August 2001, the Financial Accounting Standards Board issued SFAS No.
143, "Accounting for Asset Retirement Obligations," and SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 143
requires the recognition of a liability for the fair value of an asset
retirement obligation in the period in which the obligation is incurred, if a
reasonable estimate of fair value can be made. If a reasonable estimate of fair
value cannot be made in the period the obligation is incurred, the liability
must be recognized when a reasonable estimate of fair value can be made. Upon
initial recognition of such a liability, an equal amount must be capitalized
into the carrying amount of the related long-lived asset and subsequently
expensed over its useful life. The provisions of SFAS No. 143 are required to be
applied for fiscal years beginning after June 15, 2002. SFAS No. 144 supercedes
SFAS No. 121 and the accounting and reporting provisions of APB Opinion No. 30
for the disposal of a segment of a business. This statement establishes a single
accounting model, based on the framework in SFAS No. 121, for long-lived assets
to be disposed of by sale and resolves significant implementation issues related
to Statement 121. We adopted the provisions of SFAS No. 144 as of April 1, 2002.
We believe that adoption of SFAS No. 143 and SFAS No. 144 will not have a
material effect on our financial position or results of operations.

In April 2002, the Financial Accounting Standards Board issued SFAS No. 145,
"Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement
No. 13, and Technical Corrections." SFAS No. 145 rescinds various other
statements that required extraordinary treatment for the early extinguishment of
debt. This pronouncement allows extraordinary treatment of gains or losses
associated with extinguishment of debt when the criteria under Accounting
Principles Board Opinion No. 30, "Reporting the Results of Operations --
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions" are met. SFAS No.
145 also amends SFAS No. 13, "Accounting for Leases", such that lease
modifications which have economic effects similar to sale-leaseback transactions
are now required to be accounted for in the same manner as sale-leasebacks. The
portion of SFAS No. 145 relating to treatment of early extinguishment of debt is
effective for fiscal years beginning after May 15, 2002, while the other
provisions of this statement are effective either for transactions occurring
after that date or for financial statements issued after that date. We believe
that adoption of SFAS No. 145 will not have a material effect on our financial
position or results of operations.

16

LIQUIDITY AND CAPITAL RESOURCES

At June 30, 2002, our cash, cash equivalents and marketable securities were
$1.25 billion, a $146.3 million or 13% increase from the March 31, 2002 balance.
The $1.25 billion of cash, cash equivalents and marketable securities at June
30, 2002 includes approximately $640 million of unremitted earnings of foreign
subsidiaries that we consider permanently reinvested outside of the United
States. These earnings would be subject to United States income tax if
repatriated to the United States. The potential deferred tax liability for these
earnings is approximately $224 million. We have not provided a deferred tax
liability on any portion of the $640 million as we plan to utilize these funds
for foreign investment purposes.

Our working capital as of June 30, 2002, was $512.4 million, reflecting an
increase of $196.2 million from the March 31, 2002 balance of $316.2 million due
primarily to positive operating cash flow. A significant dollar portion of our
marketable securities is invested in securities with maturities beyond one year.
While typically yielding greater returns, this reduces reported working capital.
Because of current economic trends, we have begun investing in securities with
shorter original maturities. Our marketable securities are primarily investment
grade and highly liquid. Stockholders' equity as of June 30, 2002, was $1.5
billion.

We continue to primarily finance our growth through funds generated from
operations. For the quarter ended June 30, 2002, net cash provided by operating
activities was $219.7 million. Our primary source of cash is the sale of our
software licenses, software maintenance and professional services. We provide
financing on a portion of these sales transactions, to customers that meet our
specified standards of creditworthiness. We participate in established programs
with third-party financing institutions to securitize or sell a significant
portion of our finance receivables. We utilize certain wholly-owned, fully
consolidated special-purpose entities in these transfers. In addition, we
securitize finance receivables from customers with investment-grade credit
ratings through two special-purpose entities sponsored by third-party financial
institutions. The entities sponsored by third-party financial institutions are
multi-seller conduits with access to commercial paper markets, that purchase
interests in similar receivables from numerous other companies unrelated to us.
We have no ownership in either of the third-party financial institution
sponsored entities and have no voting influence over either of these entities'
operating and financial decisions. As a result, we do not consolidate these
entities. When we sell receivables in securitizations of software installment
contracts, we retain a beneficial interest in the securitized receivables, which
is subordinate to the interests of the entities sponsored by the third-party
financial institutions. The subordinate interests are measured and recorded at
fair value based on the present value of future expected cash flows estimated
using our best estimates of the key assumptions, including expected credit
losses and discount rates commensurate with the risks involved. We periodically
review the key assumptions and estimates used in determining the fair value of
the retained interest. The financing institutions have no recourse to our other
assets for failure of debtors to pay when due. Our retained interests are
subordinate to the investors' interests and the value of the retained interests
is subject to credit and interest rate risks on the transferred financial
assets. At June 30, 2002, our retained interest was $22 million which is
included in long-term finance receivables. Other finance receivables are sold to
third-party financial institutions on a non-recourse basis. We record such
transfers of beneficial interests in finance receivables to third-party
financing institutions as sales of such finance receivables when we have
surrendered control of such receivables, including determining that such assets
have been isolated beyond our reach and the reach of our creditors. We have not
guaranteed the transferred receivables and have no obligation upon default.
During the quarter ended June 30, 2002, we transferred a total of $199 million
of such receivables through these programs. The high credit quality of our
finance receivables and the existence of these third-party facilities extend our
ability to offer financing to qualifying customers on an ongoing basis without a
negative cash flow impact.

Net cash provided by investing activities in the quarter ended June 30, 2002
was $30.7 million, primarily related to cash receipts from the maturities of
marketable securities and sales of long-term finance receivables offset by
disbursements for the purchase of marketable securities. Net cash used in
financing activities in the quarter ended June 30, 2002 was $27.8 million, which
derived primarily from treasury stock purchases. On April 24, 2000, the board of
directors authorized the purchase of up to $500.0 million of our common stock.
During the quarter ended June 30, 2002 we purchased 2.3 million shares for $38.7
million. Since the inception of the repurchase plan, we have purchased 18.5
million shares for $348.9 million. Subsequent to June 30, 2002, the board of
directors authorized the purchase of an additional $500.0 million of our common
stock. We plan to continue to buy stock on the open market from time to time,
depending on market conditions, and other possible uses of our cash. We have no
short-term or long-term debt outstanding.

We believe that our existing cash balances and funds generated from
operations will be sufficient to meet our liquidity requirements for the
foreseeable future.

17

B. CERTAIN RISKS AND UNCERTAINTIES

Our Stock Price is Volatile.

Our stock price has been and is highly volatile. Our stock price is highly
influenced by current expectations of future revenue and earnings growth rates.
Any failure to meet anticipated revenue and earnings levels in a period or any
negative change in our perceived long-term growth prospects would likely have a
significant adverse effect on our stock price. Our historical financial results
are not necessarily indicative of future results.

The Timing, Type and Size of License Contracts Could Cause Our Quarterly
Revenues and Earnings to Fluctuate.

Our revenues and results of operations are difficult to predict and may
fluctuate substantially quarter to quarter. The timing, type and amount of our
license revenues are subject to a number of factors that make estimation of
operating results prior to the end of a quarter extremely uncertain. We
generally operate with little or no sales backlog and, as a result, license
revenues in any quarter are dependent upon contracts entered into or orders
booked and shipped in that quarter. We are also executing a larger number of
license transactions where the contract terms and conditions require us to defer
the license revenue. We provide targets for the change in our deferred license
revenue balance along with targets for revenues and earnings. A significant
amount of our license transactions are completed during the final weeks and days
of the quarter, and therefore we generally do not know whether revenues,
earnings and/or changes to the deferred license revenue balances will meet
expectations until the final days or day of a quarter.

We have a High Degree of Operating Leverage.

Our business model is characterized by a very high degree of operating
leverage. A substantial portion of our operating expenses consists of employee
and facility-related costs, which are relatively fixed over the short term. In
addition, our expense levels and hiring plans are based substantially on our
projections of future revenues. If near term demand weakens in a given quarter
or if current weak global economic conditions continue, then we may find it
difficult to meet our revenue expectations and there may be a material adverse
effect on our operating results and a resultant drop in our stock price.

We May Have Difficulty Achieving our Cash Flow from Operations Goal.

Our cash flow is and has been volatile. If our cash generated from
operations proved in some future period to be materially less than we currently
expect, our stock price could decline. Factors that could adversely affect the
cash flow from operations in the future include: reduced net earnings; increased
time required for the collection cycle of accounts receivable; an increase in
uncollectible accounts receivable; a reduced ability to securitize and syndicate
financed receivables; reduced renewal rates for maintenance; deferring less
revenue than anticipated; and a reduced average yield from marketable securities
and cash and cash equivalents balances.

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Decreasing Demand for Enterprise License Transactions Could Adversely Affect
Revenues.

Fees from enterprise license transactions have historically been a
fundamental component of our revenues. These revenues depend on our customers
planning to grow their computer processing capacity and continuing to perceive
an increasing need to use our existing software products on substantially
greater processing capacity in future periods. Prior to 2000, we licensed many
of our larger customers to operate our mainframe products on significant levels
of processing capacity in excess of their then current mainframe processing
capacity. During the past several years, we also entered into many enterprise
license agreements with our larger customers to operate our distributed systems
products on significant levels of processing capacity in excess of their then
current distributed processing capacity. In a weak economy, these customers may
elect not to license our products for additional processing capacity until their
actual processing capacity or expected future processing capacity exceeds the
capacity they have already licensed from us. If economic conditions weaken
further, demand for data processing capacity could continue to slow or even
decline. In addition, the uncertain economic environment has reduced customers'
expectations of future capacity growth, thus lessening demand for licensing
excess processing capacity in anticipation of future growth. If our customers
who have entered into multi-year capacity-based licenses for excess processing
capacity do not increase their processing capacity beyond the levels previously
licensed from us or license additional processing capacity in anticipation of
future growth, then our license revenues may not grow and our earnings could be
adversely affected.

Increased Competition and Pricing Pressures Could Adversely Affect Our Earnings.

The market for systems management software has been increasingly competitive
for the past number of years. We compete with a variety of software vendors
including IBM and Computer Associates. We derived over half of our total
revenues in fiscal 2002 from software products for IBM and IBM-compatible
mainframe computers. IBM continues, directly and through third parties, to
enhance and market its utilities for IMS and DB2 as lower cost alternatives to
the solutions provided by us and other independent software vendors. Although
such utilities are currently less functional than our solutions, IBM has begun
to invest more heavily in the IMS and DB2 utility market and appears to be
committed to competing in these markets. If IBM is successful with its efforts
to achieve performance and functional equivalence with our IMS, DB2 and other
products at a lower cost, our business may be materially adversely affected. CA
is also competing with us in these markets. Competition has led to increased
pricing pressures within the mainframe systems software markets. We continue to
reduce the cost to our customers of our mainframe tools and utilities in
response to such competitive pressures. Microsoft entered the distributed
systems monitoring and management market through its relationship with NetIQ and
is now competing with us in the market for management tools for the Windows
environment.

We provide selected metrics about our performance against our competitors
which are compiled from data only obtained from our internal field sales
organization and, accordingly, this information should not be relied upon as
coming from independent sources.

Our Products Must Remain Compatible with Ever-changing Operating and Database
Environments.

IBM, HP, Sun, Microsoft and Oracle are by far the largest suppliers of
systems and database software and, in many cases, are the manufacturers of the
computer hardware systems used by most of our customers. Historically, operating
and database system developers have modified or introduced new operating
systems, database systems, systems software and computer hardware. Such new
products could incorporate features, which perform functions currently performed
by our products, or could require substantial modification of our products to
maintain compatibility with these companies' hardware or software. Although we
have to date been able to adapt our products and our business to changes
introduced by hardware manufacturers and operating and database system software
developers, there can be no assurance that we will be able to do so in the
future. Failure to adapt our products in a timely manner to such changes or
customer decisions to forego the use of our products in favor of those with
comparable functionality contained either in the hardware or operating system
could have a material adverse effect on our business, financial condition and
operating results.

19

Future Product Development is Dependent Upon Access to Third-party Source Code.

In the past, licensees using proprietary operating systems were furnished
with "source code," which makes the operating system generally understandable to
programmers, and "object code," which directly controls the hardware and other
technical documentation. Since the availability of source code facilitated the
development of systems and applications software, which must interface with the
operating systems, independent software vendors such as us were able to develop
and market compatible software. IBM and other hardware vendors have a policy of
restricting the use or availability of the source code for some of their
operating systems. To date, this policy has not had a material effect on us.
Some companies, however, may adopt more restrictive policies in the future or
impose unfavorable terms and conditions for such access. These restrictions may,
in the future, result in higher research and development costs for us in
connection with the enhancement and modification of our existing products and
the development of new products. Although we do not expect that such
restrictions will have this adverse effect, there can be no assurances that such
restrictions or other restrictions will not have a material adverse effect on
our business, financial condition and operating results.

Future Product Development is Dependent Upon Early Access to Third-party
Operating and Database Systems.

Operating and database system software developers have in the past provided
us with early access to pre-generally available (GA) versions of their software
in order to have input into the functionality and to assure that we can adapt
our software to exploit new functionality in these systems. Some companies,
however, may adopt more restrictive policies in the future or impose unfavorable
terms and conditions for such access. These restrictions may result in higher
research and development costs for us in connection with the enhancement and
modification of our existing products and the development of new products.
Although we do not expect that such restrictions will have this adverse effect,
there can be no assurances that such restrictions or other restrictions will not
have a material adverse effect on our business, financial condition and
operating results.

Failure to Adapt to Technological Change Could Adversely Affect Our Earnings.

If we fail to keep pace with technological change in our industry, such
failure would have an adverse effect on our revenues and earnings. We operate in
a highly competitive industry characterized by rapid technological change,
evolving industry standards, changes in customer requirements and frequent new
product introductions and enhancements. During the past several years, many new
technological advancements and competing products entered the marketplace. The
distributed systems and application management markets in which we operate are
far more crowded and competitive than our traditional mainframe systems
management markets. Our ability to compete effectively and our growth prospects
depend upon many factors, including the success of our existing distributed
systems products, the timely introduction and success of future software
products, and the ability of our products to interoperate and perform well with
existing and future leading databases and other platforms supported by our
products. We have experienced long development cycles and product delays in the
past, particularly with some of our distributed systems products, and expect to
have delays in the future. Delays in new product introductions or
less-than-anticipated market acceptance of these new products are possible and
would have an adverse effect on our revenues and earnings. New products or new
versions of existing products may, despite testing, contain undetected errors or
bugs that could delay the introduction or adversely affect commercial acceptance
of such products.

Maintenance Revenue Growth Could Decline.

Maintenance revenues have increased in each of the last three fiscal years
as a result of the continuing growth in the base of installed products and the
processing capacity on which they run. Maintenance fees increase as the
processing capacity on which the products are installed increases; consequently,
we receive higher absolute maintenance fees as customers install our products on
additional processing capacity. Due to increased discounting for higher levels
of additional processing capacity, the maintenance fees on a per unit of
capacity basis are typically reduced in enterprise license agreements for our
mainframe products. In addition, customers may be entitled to reduced
maintenance percentages for entering into long-term maintenance contracts that
include prepayment of the maintenance fees or that are supported by a formal
financing arrangement. Although renewal rates remain high, should customers
migrate from their mainframe applications or find alternatives to our products,
increased cancellations could adversely impact the sustainability and growth of
our maintenance revenues. Also, renewal rates for maintenance on our distributed
systems products are lower than on our mainframe products.

20

Changes in Pricing Practices Could Adversely Affect Revenues and Earnings.

We may choose in fiscal 2003 or a future fiscal year to make changes to our
product packaging, pricing or licensing programs. If made, such changes may have
a material adverse impact on revenues or earnings. During the fourth quarter of
fiscal 2002, we revised our maintenance program to a single maintenance offering
of 24x7 support at a standard rate of 20% of the discounted price of the
associated product. In connection with this revision, we have extended our
standard warranty and initial support period to one year for all our products,
whereas prior to this revision such periods were 90 days for distributed systems
products and one year for mainframe products. Because our maintenance revenues
include the ratable recognition of the bundled fees for any initial maintenance
services covered by the related perpetual license agreement, in certain new
license transactions the extension of the initial support period for distributed
systems products will cause us to recognize more maintenance revenues over time
and less license revenues when the transactions occur. While this change in our
maintenance program will not have a material effect on our total revenues over
time, there will be a negative short-term revenue impact, which we have
considered in determining our estimates of future revenues. In addition, there
is a risk that our revenues could be negatively impacted if customers do not
accept these changes to the maintenance program and choose to license competing
products instead.

Our Customers May Not Accept our Product Strategies.

Historically, we have focused on selling software products to address
specific customer problems associated with their applications. We are now
integrating multiple software products and offering packaged solutions for
customers' systems. There can be no assurance that customers will perceive a
need for such solutions. In addition, there may be technical difficulties in
integrating individual products into a combined solution that may delay the
introduction of such solutions to the market or adversely affect the demand for
such solutions.

Risks Related to Business Combinations.

As part of our overall strategy, we have acquired or invested in, and plan
to continue to acquire or invest in, complementary companies, products, and
technologies and to enter into joint ventures and strategic alliances with other
companies. Risks commonly encountered in such transactions include: the
difficulty of assimilating the operations and personnel of the combined
companies; the risk that we may not be able to integrate the acquired
technologies or products with our current products and technologies; the
potential disruption of our ongoing business; the inability to retain key
technical and managerial personnel; the inability of management to maximize our
financial and strategic position through the successful integration of acquired
businesses; and decreases in reported earnings as a result of charges for
in-process research and development and amortization of acquired intangible
assets.

In order for us to maximize the return on our investments in acquired
companies, the products of these entities must be integrated with our existing
products. These integrations can be difficult and unpredictable, especially
given the complexity of software and that acquired technology is typically
developed independently and designed with no regard to integration. The
difficulties are compounded when the products involved are well established
because compatibility with the existing base of installed products must be
preserved. Successful integration also requires coordination of different
development and engineering teams. This too can be difficult and unpredictable
because of possible cultural conflicts and different opinions on technical
decisions and product roadmaps. There can be no assurance that we will be
successful in our product integration efforts or that we will realize the
expected benefits.

With each of our acquisitions, we have initiated efforts to integrate the
disparate cultures, employees, systems and products of these companies.
Retention of key employees is critical to ensure the continued advancement,
development, support, sales and marketing efforts pertaining to the acquired
products. We have implemented retention programs to keep many of the key
technical, sales and marketing employees; nonetheless, we have lost some key
employees and may lose others in the future.

21

Enforcement of Our Intellectual Property Rights.

We rely on a combination of copyright, patent, trademark, trade secrets,
confidentiality procedures and contractual procedures to protect our
intellectual property rights. Despite our efforts to protect our intellectual
property rights, it may be possible for unauthorized third parties to copy
certain portions of our products or to reverse engineer or obtain and use
technology or other information that we regard as proprietary. There can also be
no assurance that our intellectual property rights would survive a legal
challenge to their validity or provide significant protection for us. In
addition, the laws of certain countries do not protect our proprietary rights to
the same extent as do the laws of the United States. Accordingly, there can be
no assurance that we will be able to protect our proprietary technology against
unauthorized third party copying or use, which could adversely affect our
competitive position.

Possibility of Infringement Claims.

From time to time, we receive notices from third parties claiming
infringement by our products of patent and other intellectual property rights.
We expect that software products will increasingly be subject to such claims as
the number of products and competitors in our industry segments grow and the
functionality of products overlap. In addition, we may receive more patent
infringement claims as companies increasingly seek to patent their software and
business methods and enforce such patents, especially given the increase in
software and business method patents issued during the past several years.
Regardless of its merit, responding to any such claim could be time-consuming,
result in costly litigation and require us to enter into royalty and licensing
agreements which may not be offered or available on terms acceptable to us. If a
successful claim is made against us and we fail to develop or license a
substitute technology, our business, results of operations or financial position
could be materially adversely affected.

Risks Related to International Operations.

We have committed, and expect to continue to commit, substantial resources
and funding to build our international service and support infrastructure.
Operating costs in many countries, including many of those in which we operate,
are higher than in the United States. In order to increase international sales
in fiscal 2003 and subsequent periods, we must continue to globalize our
software product lines; expand existing and establish additional foreign
operations; hire additional personnel; identify suitable locations for sales,
marketing, customer service and development; and recruit international
distributors and resellers in selected territories. Future operating results are
dependent on sustained performance improvement by our international offices,
particularly our European operations. Our operations and financial results
internationally could be significantly adversely affected by several risks such
as changes in foreign currency exchange rates, sluggish regional economic
conditions and difficulties in staffing and managing international operations.
Generally, our foreign sales are denominated in our foreign subsidiaries' local
currencies. If these foreign currency exchange rates change unexpectedly, we
could have significant gains or losses. Many systems and applications software
vendors are experiencing difficulties internationally.

We maintain a software development office in India which operates as an
extension of our primary development offices and we contract with third-party
developers in India. To date, the dispute between India and Pakistan involving
the Kashmir region has not adversely affected our operations in India. Should we
be unable to conduct operations in India in the future, we believe that our
business would not be materially adversely affected.

Conditions in Israel.

Our scheduling, security, output management and Enterprise Application
Management (EAM) development operations are conducted primarily in Israel and,
accordingly, we are directly affected by economic, political and military
conditions in Israel. Any major hostilities involving Israel or the interruption
or curtailment of trade between Israel and its present trading partners could
materially adversely affect our business, operating results and financial
condition. Since the establishment of the State of Israel in 1948, a state of
hostility has existed, varying in degree and intensity, between Israel and the
Palestinian people and the Arab countries. In addition, Israel and companies
doing business with Israel have been the subject of an economic boycott by the
Arab countries since Israel's establishment. Although Israel has entered into
various agreements with certain Arab countries and the Palestinian Authority,
and various declarations have been signed in connection with efforts to resolve
some of the economic and political problems in the Middle East, we cannot
predict whether or in what manner these problems will be resolved. We maintain
comprehensive contingency and business continuity plans, and to date, the
current conflict in the region and hostilities within Israel have not caused
disruption of our operations located in Israel.

22

In addition, certain of our Israeli employees are currently obligated to
perform annual reserve duty in the Israel Defense Forces and are subject to
being called for active military duty at any time. Although our businesses
located in Israel have historically operated effectively under these
requirements, we cannot predict the effect of these obligations on our
operations in the future.

Possible Adverse Impact Of Interpretations of Existing Accounting
Pronouncements.

On April 1, 1998 and 1999 we adopted AICPA SOP 97-2, "Software Revenue
Recognition," and SOP 98-9 "Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions," respectively. The adoption
of these standards did not have a material impact on our financial position or
results of operations. Based on our reading and interpretation of these SOPs, we
believe that our current sales contract terms and business arrangements have
been properly reported. However, the AICPA and its Software Revenue Recognition
Task Force continue to issue interpretations and guidance for applying the
relevant standards to a wide range of sales contract terms and business
arrangements that are prevalent in the software industry. Also, the SEC has
issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements," which provides guidance related to revenue recognition based on
interpretations and practices followed by the SEC. Future interpretations of
existing accounting standards or changes in our business practices could result
in future changes in our revenue accounting policies that could have a material
adverse effect on our business, financial condition and results of operations.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to a variety of risks, including foreign currency exchange
rate fluctuations and changes in the market value of our investments. In the
normal course of business, we employ established policies and procedures to
manage these risks including the use of derivative instruments. There have been
no material changes in our foreign exchange risk management strategy or our
marketable securities subsequent to March 31, 2002, therefore our foreign
currency exchange rate risk and interest rate risk related to investments remain
substantially unchanged from the description in our Form 10-K for the year ended
March 31, 2002.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are subject to various legal proceedings and claims, either asserted or
unasserted, which arise in the ordinary course of business. Management does not
believe that the outcome of any of these legal matters will have a material
adverse effect on our financial position or results of operations.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits.

None

(b) Reports on Form 8-K.

Current report filed on August 1, 2002, which contained exhibits of
the Written Statement of Robert E. Beauchamp, Chief Executive Officer
of BMC Software, Inc. dated July 31, 2002 and the Written Statement of
John W. Cox, Chief Financial Officer of BMC Software, Inc. dated July
30, 2002, in each case, delivered pursuant to SEC Order 4-460.

Current report filed on August 13, 2002, which contained exhibits of
the Written Statement of Robert E. Beauchamp, Chief Executive Officer
of BMC Software, Inc. dated August 13, 2002 and the Written Statement
of John W. Cox, Chief Financial Officer of BMC Software, Inc. dated
August 13, 2002, in each case, pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

BMC SOFTWARE, INC.

By: /s/ Robert E. Beauchamp
--------------------------------------------
Robert E. Beauchamp
President and Chief Executive Officer
August 13, 2002

By: /s/ John W. Cox
--------------------------------------------
John W. Cox
Vice President, Chief Financial Officer and
Chief Accounting Officer
August 13, 2002

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