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 SEPTEMBER 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
incorporation or organization) Identification No.)

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 November 8, 2002, there were outstanding 235,452,869 shares of Common
Stock, par value $.01, of the registrant.

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BMC SOFTWARE, INC. AND SUBSIDIARIES

QUARTER ENDED SEPTEMBER 30, 2002

INDEX

PAGE
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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Balance Sheets as of March 31, 2002 and
September 30, 2002 (Unaudited)...................................... 3
Condensed Consolidated Statements of Operations and Comprehensive
Income (Loss) for the three months and six months ended
September 30, 2001 and 2002 (Unaudited) ............................ 4
Condensed Consolidated Statements of Cash Flows for the six
months ended September 30, 2001 and 2002 (Unaudited)................ 5
Notes to Condensed Consolidated Financial Statements (Unaudited)...... 6

Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition................................................... 11

Item 3. Quantitative and Qualitative Disclosures about Market Risk............... 25

Item 4. Controls and Procedures.................................................. 25

PART II. OTHER INFORMATION

Item 1. Legal Proceedings........................................................ 26

Item 2. Submission of Matters to a Vote of Security Holders...................... 26

Item 3. Exhibits and Reports on Form 8-K......................................... 27

Signatures............................................................... 28

Certifications........................................................... 29

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 INCOME (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 ensure 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 PER SHARE

Basic earnings per share (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 the three-month periods ended September 30, 2001 and 2002, the
treasury stock method effect of 36.8 million and 37.0 million weighted options,
respectively, and 0.6 million and 0.0 weighted unearned restricted shares,
respectively, has been excluded from the calculation of EPS as it is
anti-dilutive. For the six-month periods ended September 30, 2001 and 2002, the
treasury stock method effect of 37.4 million and 37.1 million weighted options,
respectively, and 0.7 million and 0.0 weighted unearned restricted shares,
respectively, has been excluded from the calculation of EPS as it is
anti-dilutive. The following table summarizes the basic and diluted EPS
computations for the three months and six months ended September 30, 2001 and
2002:

6

(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, which includes the Mainframe Data
Management and Distributed Systems Data Management product lines, Enterprise
Systems Management Software, which includes the PATROL(R), MAINVIEW(R) and
Scheduling & Output Management product lines, and Other Software, which includes
the High Potential product lines of Storage Management, Security Management,
Enterprise Applications Management, Subscription Services and Linux Management,
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 three months and six
months ended September 30, 2001 and 2002 reflect this change in the composition
of the segments.

Segment performance is measured based on contribution margin, which reflects
only the direct controllable expenses of the segments and does 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.

(4) 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 also has adopted an employee stock purchase plan under
which rights to purchase the Company's common stock are granted at 85% of the
lesser of the market value of the common stock at the offering date or on the
exercise date.

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, Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," employs
fair value-based measurement and generally results in the recognition of
compensation expense 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 generally 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

8

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 common stock on the date of grant, no compensation expense is
recorded.

For the three months ended September 30, 2001 and 2002, the Company recorded
compensation expense of $4.0 million and $0.6 million, respectively, for
restricted stock grants. The expense for the three months ended September 30,
2001 includes $3.1 million of merger-related compensation charges related to
restricted shares issued as part of the Evity acquisition. For the six months
ended September 30, 2001 and 2002, the Company recorded compensation expense of
$7.7 million and $1.9 million, respectively, for restricted stock grants. The
expense for the six months ended September 30, 2001 and 2002 includes $6.2
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 awards estimated using the Black-Scholes
option pricing model, which is consistent with 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 pro forma amounts shown below:

On September 10, 2002, pursuant to an Offer to Exchange, the Company
offered to certain U.S. employees the right to exchange outstanding stock
options with an exercise price of $30.00 per share or more granted under certain
of the Company's stock incentive plans for new options that cover a lesser
number of shares to be granted under those stock incentive plans. Amendments to
the stock incentive plans to permit the offer were approved by the Company's
stockholders at the Company's Annual Meeting held on August 29, 2002. The offer
expired on October 9, 2002. The Company accepted for exchange options to
purchase an aggregate of 6.5 million shares of Company common stock,
representing approximately 88% of the options that were eligible for the
exchange. These options have been cancelled and are no longer outstanding.
Subject to the terms and conditions of the Offer to Exchange, the Company will
issue new options at fair market value as of the date of grant to purchase an
aggregate of 2.4 million shares of Company common stock in exchange for such
exchanged options at least six months and one day following the cancellation of
the options.

(5) 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.

BMC assigned its goodwill to the Company's applicable reporting units and
tested its goodwill for impairment as of April 1, 2002 in accordance with SFAS
No. 142. The fair value of each of the Company's reporting units with goodwill
assigned exceeded the respective carrying value of the reporting unit's
allocated net assets, including goodwill, and therefore no goodwill was
considered impaired as of April 1, 2002.

9

The following reconciles the Company's reported net earnings (loss) and
earnings (loss) per share to those amounts that would have resulted had there
been no amortization of goodwill and intangible assets with indefinite lives for
all periods presented:

(6) 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. As
part of this plan, the Company reduced its workforce, discontinued certain
business information integration products as a result of the dissolution of that
business unit and closed 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 September 30, 2002, $1.9 million of severance and facilities costs
related to actions completed under the restructuring plan remained accrued for
payment in future periods.

(7) PENDING BUSINESS COMBINATION

On September 20, 2002, the Company entered into an acquisition agreement
with Peregrine Systems, Inc. (Peregrine) and Peregrine Remedy, Inc. to acquire
the assets of the Remedy(R) business for $350 million in cash plus the
assumption of certain liabilities of the Remedy business. The pending
acquisition is subject to the entry of a sale order by the U.S. bankruptcy
court. In connection with the acquisition, the Company has provided up to $110.0
million of debtor-in-possession financing to Peregrine which is secured by
first-priority liens and security interests in substantially all of the assets
of Peregrine and its subsidiaries. As of September 30, 2002, $46.2 million,
including fees, was outstanding under this debtor-in-possession financing
arrangement and is included in other current assets in the accompanying
condensed consolidated balance sheet at that date. Under the terms of the
debtor-in-possession credit agreement, all outstanding amounts will be repaid to
the Company in conjunction with the close of the acquisition. If the acquisition
does not close by December 31, 2002, the debtor-in-possession credit agreement
will terminate and all outstanding borrowings will become immediately due and
payable. As noted above, the Company has the first priority among Peregrine's
creditors and therefore believes the amount outstanding at December 31, 2002, if
any, will be realizable.

10

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

This section of the Report 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
Annual Report on Form 10-K for the year ended March 31, 2002.

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, goodwill and 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 Annual Report on Form 10-K for the year ended
March 31, 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 Income (Loss) bear to total revenues. These comparisons of
financial results are not necessarily indicative of future results.

11

REVENUES

We generate revenues from licensing software, providing maintenance,
enhancement and support for previously licensed products and providing
professional services. We generally utilize written contracts as the means to
establish the terms and conditions by which our products, support and services
are sold to our customers.

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." These statements provide
guidance on applying generally accepted accounting principles in recognizing
revenue on software transactions. In applying these statements, we recognize
software license fees upon meeting the following four criteria: execution of the
signed contract, delivery of the underlying products to the customer and the
acceptance of such products by the customer, determination that the software
license fees are fixed and determinable, and determination that collection of
the software license fees is probable. In instances when any one of the four
criteria are not met, we will either defer recognition of the software license
revenue until the criteria are met or will recognize the software license
revenue on a ratable basis, as required by SOPs 97-2 and 98-9. Maintenance,
enhancement and support revenues are recognized ratably over the term of the
arrangement on a straight-line basis. Revenues from license and maintenance
transactions that are financed are generally recognized in the same manner as
those requiring current payment. We have an established business practice of
offering installment contracts to customers and have a history of successfully
enforcing original payment terms without making concessions. Further, the
payment obligations are unrelated to product implementation or any other
post-transaction activity. Revenues from sales through agents, distributors and
resellers are recorded either at the gross amount charged the customer or net of
commissions paid, based on the economic risks and ongoing product support
responsibilities we assume. On occasion, we have purchased goods or services for
our operations from customers at or about the same time that we licensed our
software to these customers. License revenues from such transactions represent
less than one percent of our total license revenues in any period. Revenues from
professional services are typically recognized as the services are performed for
time-and-materials contracts, or on a percentage-of-completion basis.

When several elements, including software licenses, maintenance, enhancement
and support and professional services, are sold to a customer through a single
contract, the revenues from such multiple-element arrangements are allocated to
each element based upon the residual method, whereby the fair value of the
undelivered elements of the contract is deferred. We have established
vendor-specific objective evidence of fair value for maintenance, enhancement
and support and professional services. Accordingly, software license fees are
recognized under the residual method for arrangements in which the software is
licensed with maintenance, enhancement and support and/or professional services,
and where the maintenance, enhancement and support and/or professional services
are not essential to the functionality of the delivered software. In those
instances where professional services are essential to the functionality of the
software, contract accounting is applied to both the software license and
services elements of the arrangement. In the event a contract contains terms
which are inconsistent with our vendor-specific objective evidence, all revenues
from the contract are deferred until such evidence is established or are
recognized on a ratable basis.

Based on our interpretation of SOP 97-2 and SOP 98-9, 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.

12

Product License Revenues

Our product license revenues primarily consist of fees related to products
licensed to customers on a perpetual basis. Product license fees can be
associated with a customer's licensing of a given software product for the first
time or with a customer's purchase of the right to run a previously licensed
product on a larger computer or additional computers. The license fees for
additional processing capacity 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, 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
throughout fiscal 2002 and the first half of fiscal 2003 have resulted in
reduced IT spending by many of our customers as compared to historical levels.
Tighter budgets have caused many customers to choose smaller transactions in
terms of dollar value during these periods. License revenues decreased 8% and
18%, respectively, for the three months and six months ended September 30, 2002,
as compared to the same periods in fiscal 2002. For the three-month period, the
decline was primarily due to the negative impact of internal and external
factors on our PATROL revenues as discussed below under Product Line Revenues
and the reduction in license revenues as a result of our new maintenance program
discussed below under Maintenance, Enhancement and Support Revenues. In addition
to these issues for the six-month period, there was also a significant increase
in transactions where the terms and conditions within our contracts resulted in
the deferral of license revenue and in term license transactions. As of March
31, 2002 and September 30, 2002, our total deferred license revenue balance was
$168.9 million and $211.9 million, respectively.

Our North American operations generated 55% and 54% of license revenues in
the three months ended September 30, 2001 and 2002, respectively, and 60% and
59% in the six months ended September 30, 2001 and 2002, respectively. Decreases
in PATROL and Distributed Systems Data Management license revenues were the
largest contributors to the 10% decline in North American license revenues in
the three months ended September 30, 2002, more than offsetting increases in
MAINVIEW and Storage Management license revenues. The 18% decline for the six
months ended September 30, 2002 was primarily due to decreases in Mainframe Data
Management and PATROL license revenues which more than offset increases in
Scheduling and Output Management and Storage Management license revenues.

International license revenues represented 45% and 46% of total license
revenues in the three months ended September 30, 2001 and 2002, respectively,
and 40% and 41% in the six months ended September 30, 2001 and 2002,
respectively. International license revenues declined 6% and 18% in the three
months and six months ended September 30, 2002, respectively, from the
comparable periods in fiscal 2002, principally due to decreased PATROL product
license fees in both periods. This decline was primarily caused by weakening
demand in Europe and a greater demand for term-based licenses, which, in
general, are deferred and recognized evenly over the license period. For the
three months ended September 30, 2002, the decrease in PATROL license revenues
more than offset increased license revenues for our Mainframe Data Management
products. The international license revenue decreases for both periods were net
of 3% increases due to foreign currency exchange rate changes during the
periods, after giving effect to our foreign currency hedging program.

13

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 equaled 15% to 20% of the discounted price of the
product, prior to the program change in the fourth quarter of fiscal 2002
discussed below. 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. Maintenance revenues also include the ratable recognition of the
bundled fees for any initial maintenance services covered by the related
perpetual license agreement.

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. In connection with this
revision, we 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.

Maintenance revenues increased 7% for the three months and six months ended
September 30, 2002 over the comparable prior year periods 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. These
discounts, combined with the reduced maintenance percentages for long-term
contracts discussed above and the recent decline in our license revenues, have
led to lower growth rates for our maintenance revenue. Historically, we have
enjoyed high maintenance renewal rates for our products.

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 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 Management, Enterprise Applications
Management, Subscription Services and Linux Management. Our objective for this
group is to develop our business in fast-growing markets.

14

Our Enterprise Data Management solutions combined represented 47% of total
software revenues for the three months ended September 30, 2001 and 2002, and
49% and 47% for the six months ended September 30, 2001 and 2002, respectively.
Total software revenues for this group declined 2% and 10%, respectively, for
the three months and six months ended September 30, 2002, from the same periods
in fiscal 2002. Maintenance revenue was down slightly in both periods,
accounting for the majority of the decrease for the three-month period. This
decline was primarily the result of continued pricing pressure for our mainframe
data management products and slowing capacity growth, which was not sufficient
to offset these reduced prices. For the six months ended September 30, 2002,
decreased license revenues in the first quarter of fiscal 2003 were the primary
contributor to the total revenue decline due to smaller dollar transaction sizes
discussed above.

Our Enterprise Systems Management solutions combined contributed 45% of
total software revenues for the three months ended September 30, 2001 and 2002,
and 43% and 44% for the six months ended September 30, 2001 and 2002,
respectively. Total software revenues for this group declined 2% and 4% for the
three months and six months ended September 30, 2002, respectively, from the
same periods in fiscal 2002. The decreases in both periods are 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. These
external factors, coupled with delays in customer purchase decisions resulting
from delays in our release of significant enhancements to components of the
PATROL product line, have had a direct negative impact on PATROL license
revenues, more than offsetting license revenue increases for the MAINVIEW and
Scheduling & Output Management product lines and maintenance revenue increases
across the Enterprise Systems Management solutions. We expect to deliver the
remaining key PATROL enhancements during the third quarter of fiscal 2003. In
addition, we have assigned experienced management personnel to lead the PATROL
product line who have a track record of timely delivery and a focus on process
and quality that will help ensure we meet our commitments to provide continuing
product improvements to our customers. To further improve the PATROL license
revenue performance in the future, we have expanded our inside sales force in an
attempt to bring the PATROL products to new customers.

Our High Potential product lines contributed 7% and 8% of total software
revenues for the three months ended September 30, 2001 and 2002, and the six
months ended September 30, 2001 and 2002, respectively. Total software revenues
for this group grew 14% and 13%, respectively, for the three months and six
months ended September 30, 2002, from the same periods in fiscal 2002. Though we
continue to expect high growth in the markets these products address, total
license revenue for our High Potential products declined in both periods. We
evaluate our investments in these product lines on an ongoing basis and will
increase or decrease such investments as necessary, based on our expectations of
the products' future growth. The primary contributors to the total revenue
growth in both periods were license revenue increases for our Storage Management
products and maintenance revenue increases across all High Potential product
lines, which more than offset declines in Enterprise Applications Management
license revenue.

Professional Services Revenues

Professional services revenues, representing fees from implementation,
integration and education services performed during the period, decreased 11%
during the three months and six months ended September 30, 2002, over the
comparable prior year periods. 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

Beginning in fiscal 2002, we increased our focus on expense control to
better align our cost structure with the realities of a more difficult revenue
environment. This initiative included headcount reductions across all divisions
and geographies, office consolidations, elimination of certain product lines and
reductions in discretionary spending on items such as travel, consulting fees
and equipment. We were able to reduce these costs significantly while
maintaining our industry-leading product quality, customer support and sales
relationships.

15

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 15% and 19%,
respectively, for the three months and six months ended September 30, 2002
compared to the same periods in fiscal 2002. Contributing to the decline in
selling and marketing expenses were decreases in sales commissions, advertising
and marketing programs, bad debt expense related to license billings, personnel
related costs and travel and entertainment costs.

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. The following table summarizes the amounts capitalized and
amortized for the three months and six months ended September 30, 2001 and 2002.
Amortization for these periods includes amounts accelerated for certain software
products that were not expected to generate sufficient future revenues to
realize the carrying value of the assets.

The decrease in capitalized costs from fiscal 2002 to fiscal 2003 is
primarily due to a reduction in the number of current development projects which
qualify for capitalization under SFAS No. 86. We expect that software cost
capitalization will remain at this lower level in the future. The reduction in
capitalizable projects and the acceleration of amortization in prior periods has
resulted in a decline in amortization expense for the three months and six
months ended September 30, 2002, compared to the same periods in fiscal 2002.
During the quarter ended September 30, 2001, we also wrote off software assets
totaling $14.9 million associated with certain business information integration
products that were discontinued during that quarter. This charge is included in
restructuring and severance costs in the accompanying Statements of Operations
and Comprehensive Income (Loss) for the three months and six months ended
September 30, 2001.

Research and development expenses increased 6% and 5% for the three months
and six months ended September 30, 2002, respectively, compared to the same
periods in fiscal 2002, primarily due to the net expense effect of software cost
capitalization and amortization detailed above, which more than offset reduced
personnel costs.

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 17% and 19% decreases in these costs for the three months and six
months ended September 30, 2002, respectively, compared to the same periods in
fiscal 2002 resulted primarily from the 11% declines in professional services
revenues and the related headcount reductions, particularly within the PATROL
solutions, during these periods combined with lower external consulting fees.

16

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 decrease in general
and administrative expenses for each of the three months and six months ended
September 30, 2002 over the same periods in the prior year was primarily
attributable to decreased legal and other professional fees, shipping costs and
bad debt expense, offset slightly by higher personnel costs.

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, software and other
intangible assets. Prior to April 1, 2002, we were amortizing all of these
intangibles over three to five-year periods, which reflected the estimated
useful lives of the respective assets. As of April 1, 2002, we adopted SFAS No.
142, "Goodwill and Other Intangible Assets." In accordance with this Statement,
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 second quarter of fiscal 2002 and by approximately $72
million from the amount recorded in the first six months of fiscal 2002. See
Note 5 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 there been no amortization of
goodwill and intangible assets with indefinite lives for all periods presented.

Restructuring and Severance Costs

During the first two quarters of fiscal 2002, we implemented a restructuring
plan to better align our cost structure with prevailing market conditions. The
plan included the involuntary termination of 447 and 427 employees during those
quarters, respectively. These actions were across all divisions and geographies
and the affected employees received cash severance packages. During the quarter
ended September 30, 2001, the Company also discontinued certain business
information integration products and announced the closure of certain locations
throughout the world. A charge of $12.0 million was recorded during the quarter
ended June 30, 2001 for severance and related expenses. A charge of $32.7
million was recorded during the quarter ended September 30, 2001 for employee
severance, the write-off of software assets related to discontinued products and
office closures. The $0.2 million of restructuring and severance costs recorded
during the first half of fiscal 2003 is primarily related to the adjustment of
facilities accruals initially recorded during fiscal 2002.

Merger-Related Costs and Compensation Charges

Merger-related compensation charges of $3.1 million and $5.8 million for the
three months and six months ended September 30, 2001, respectively, and $0.6
million for the six months ended September 30, 2002 are 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. Vesting was
complete during the first quarter of fiscal 2003.

OTHER INCOME, NET

For the three months and six months ended September 30, 2002, other income,
net was $17.1 million and $26.6 million, respectively, reflecting a decrease of
6% and 1% from the same periods of fiscal 2002. Other income, net consists
primarily of interest earned on cash, cash equivalents and marketable securities
and gains and losses on marketable securities. The decrease in other income, net
for the second quarter is primarily due to lower interest income resulting from
lower interest rates and the investment of a larger portion of our portfolio in
short-term securities. This decrease in interest income was partially offset by
an increase due to the growth in our total cash and marketable securities
balance. For the six months ended September 30, 2002, the decrease in interest
income was also partially offset by a $1.1 million reduction in losses on
marketable securities. In the quarters ended June 30, 2001 and 2002, we wrote
off $7.4 million and $6.3 million, respectively, of marketable securities.

17

INCOME TAX PROVISION (BENEFIT)

For the three months and six months ended September 30, 2002, income tax
expense was $4.0 million and $5.5 million, respectively, compared to income tax
benefits of $21.7 million and $35.1 million for the same periods in fiscal 2002.
The increase in income tax expense is directly attributable to the increase in
pre-tax earnings discussed above. Our effective tax rate was 28% and 26% for the
three months and six months ended September 30, 2002, respectively, compared to
29% in the same periods of fiscal 2002.

On August 26, 2002, we received a Revenue Agent's Report ("RAR") from the
Internal Revenue Service ("IRS") related to the examination of our U.S.
corporate income tax returns for the fiscal years ended March 31, 1998 and 1999.
The RAR is not a Statutory Notice of Deficiency, and we are protesting the
findings in the RAR. The report proposes tax increases resulting from
adjustments to the transfer pricing arrangement we have with one of our foreign
subsidiaries. The IRS claims in the RAR that our U.S. operations have not been
adequately compensated by the foreign subsidiary for the right to distribute our
technology in a specific territory. We believe that we have meritorious defenses
to the proposed adjustments and that adequate provisions for income taxes have
been made, and therefore we believe that the ultimate resolution of the issues
will not have a material adverse impact on our consolidated financial position
or results of operations.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

As of April 1, 2002, we 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 assigned our
goodwill to our applicable reporting units and tested the goodwill for
impairment as of April 1, 2002 in accordance with SFAS No. 142. The fair value
of each of our reporting units with goodwill assigned exceeded the respective
carrying value of the reporting unit's net assets, including goodwill, and
therefore no goodwill was considered impaired as of April 1, 2002. As such, the
primary impact of adopting this Statement is the elimination of amortization
expense related to our goodwill and intangible assets with indefinite lives from
our Consolidated Statement of Operations and Comprehensive Income (Loss). See
Note 5 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 there been no amortization of
goodwill and intangible assets with indefinite lives for all periods presented.

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.

In June 2002, the Financial Accounting Standards Board issued SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities," which
nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS No. 146 generally
requires that the liability for a cost associated with an exit or disposal
activity be recognized and measured initially at its fair value in the period in
which the liability is incurred. The provisions of this Statement are effective
for exit or disposal activities initiated after December 31, 2002. We believe
that adoption of SFAS No. 146 will not have a material effect on our financial
position or results of operations.

18

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2002, our cash, cash equivalents and marketable securities
were $1.23 billion, a $121.7 million or 11% increase from the March 31, 2002
balance. A portion of the $1.23 billion of cash, cash equivalents and marketable
securities at September 30, 2002 is held in international locations and was
largely generated from our international operations. Our international
operations have generated approximately $630 million of earnings for which U.S.
income taxes have not been recorded. These earnings would be subject to U.S.
income tax if repatriated to the United States. The potential deferred tax
liability for these earnings is approximately $221 million; however, we have not
provided a deferred tax liability on any portion of the $630 million as we plan
to utilize our cash in international locations for foreign investment purposes.
As discussed in Note 7 to the accompanying condensed consolidated financial
statements, we have entered into an acquisition agreement to acquire the assets
of the Remedy business from Peregrine for $350 million in cash plus the
assumption of certain liabilities of the Remedy business. During the period
prior to the closing of this acquisition, we have committed up to $110.0 million
of debtor-in-possession financing for Peregrine which we plan to fund with our
available cash. We also plan to fund the purchase price, net of outstanding
borrowings under the debtor-in-possession financing, from our available cash at
the closing of the acquisition. We expect to utilize cash held in international
locations to fund a portion of the purchase price based upon the valuation of
the foreign assets of the Remedy business acquired.

Our working capital as of September 30, 2002, was $477.5 million, reflecting
an increase of $161.3 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, and while typically yielding greater returns, investing in such securities
reduces reported working capital. Our marketable securities are primarily
investment grade and highly liquid. Because of current economic trends, we have
begun investing in securities with shorter original maturities. Stockholders'
equity as of September 30, 2002, was $1.4 billion.

We continue to primarily finance our operations through funds generated from
operations. For the six months ended September 30, 2002, net cash provided by
operating activities was $323.1 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 September 30, 2002, our retained interest was $24.0 million and is
included in long-term finance receivables in the accompanying Condensed
Consolidated Balance Sheet as of that date. 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
financial 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 six months ended September 30, 2001 and 2002, we transferred a total
of $167.2 million and $244.7 million, respectively, 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 used in investing activities in the six months ended September 30,
2002 was $20.2 million, primarily related to the debtor-in-possession financing
provided to Peregrine, as discussed in Note 7 to the accompanying Condensed
Consolidated Financial Statements. Proceeds from sales of marketable securities
more than offset disbursements for the purchase of marketable securities during
the period. Net cash used in financing activities in the six months ended
September 30, 2002 was $102.7 million, which primarily related to purchases of
our common stock. On April 24, 2000, the board of directors authorized the
purchase of up to $500.0 million of our common stock. During the six months
ended September 30, 2002 we purchased 8.1 million shares for $120.6 million.
Since the inception of the repurchase plan, we have purchased 24.3 million
shares for $430.8 million. During the quarter ended

19

September 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
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.

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, earnings and cash flows.
Any failure to meet anticipated revenue, earnings and cash flow 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, earnings and cash flows. 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, cash flows and/or changes to the deferred license revenue
balances will meet expectations until the first few days of the following
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 sell
financed receivables; reduced renewal rates for maintenance; and a reduced
average yield from marketable securities and cash and cash equivalents balances.

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 decline. In addition, the
uncertain

20

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. In
addition, a reduction in Unix shipments from hardware manufacturers such as Sun
Microsystems, HP and IBM coupled with delays in customer purchase decisions
resulting from delays in our release of significant enhancements to components
of the PATROL product line, have had a direct negative impact on PATROL license
revenues. While we have taken internal steps to improve the performance of the
PATROL product line, if we are not successful with such measures or if there is
continued weak demand for distributed systems management software for Unix
hardware, then our license revenues from our PATROL product line will 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 also face competition from several niche software vendors,
particularly for our distributed systems product lines.

From time to time, we publicly provide selected metrics about our
performance against our competitors which are compiled from data obtained solely
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.

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.

21

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 ensure 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. These discounts, combined with the recent decline in our
license revenues, have led to lower growth rates for our maintenance revenue.
Further declines in our license revenue and/or increased discounting could lead
to declines in our maintenance revenues. 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.

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.

22

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, sales and managerial personnel; the inability of management to
maximize our financial and strategic position through the successful integration
of acquired businesses; the risk that revenues from acquired companies, products
and technologies do not meet expectations; 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.

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.

23

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 Applications
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.

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.

24

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
marketable securities. 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 Annual
Report on Form 10-K for the year ended March 31, 2002.

ITEM 4. CONTROLS AND PROCEDURES

Within the 90 days prior to the date of this report, the Company carried out
an evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based
upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures are effective in
timely alerting them to material information relating to the Company (including
its consolidated subsidiaries) required to be included in the Company's periodic
SEC filings.

There were no significant changes in the Company's internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation.

25

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 2. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At BMC Software Inc.'s Annual Meeting of Stockholders held on August 29,
2002 the following proposals were adopted by the margins indicated.

26

ITEM 3. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits.

10.1 Acquisition Agreement by and among Peregrine Systems, Inc.,
Peregrine Remedy, Inc. and BMC Software, Inc. dated as of
September 20, 2002.

10.2 First Amendment to Acquisition Agreement dated as of September 24,
2002.

10.3 Second Amendment to Acquisition Agreement dated as of October 25,
2002.

10.4 Debtor in Possession Credit Agreement dated as of September 24, 2002
by and among Peregrine Systems, Inc., Peregrine Remedy, Inc., the
subsidiaries of Borrowers named therein and BMC Software, Inc.

(b) Reports on Form 8-K.

On August 1, 2002, the Company filed a Current Report on Form 8-K, dated
August 1, 2002, reporting under Item 9 the filing of written statements of
the Company's Chief Executive Officer and Chief Financial Officer pursuant
to Securities and Exchange Commission Order 4-460.

On August 13, 2002, the Company filed a Current Report on Form 8-K,
dated August 13, 2002, reporting under Item 9 the filing of written
statements of the Company's Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

27

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
November 11, 2002

By: /s/ JOHN W. COX
-------------------------------------------
John W. Cox
Vice President, Chief Financial Officer and
Chief Accounting Officer
November 11, 2002

28

CERTIFICATIONS

CEO CERTIFICATION

I, Robert E. Beauchamp, certify that:

1. I have reviewed this quarterly report on Form 10-Q of BMC Software, Inc.
(the "registrant");

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:

a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;

b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and

c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):

a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and

6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.

Date: November 11, 2002

By: /s/ ROBERT E. BEAUCHAMP
--------------------------------
Robert E. Beauchamp
Chief Executive Officer

29

CFO CERTIFICATION

I, John W. Cox, certify that:

1. I have reviewed this quarterly report on Form 10-Q of BMC Software, Inc.
(the "registrant");

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:

a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;

b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and

c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):

a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and

6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.

Date: November 11, 2002

By: /s/ JOHN W. COX
------------------------------------
John W. Cox
Chief Financial Officer

30

EXHIBIT INDEX

10.1 Acquisition Agreement by and among Peregrine Systems, Inc.,
Peregrine Remedy, Inc. and BMC Software, Inc. dated as of September
20, 2002.

10.2 First Amendment to Acquisition Agreement dated as of September 24,
2002.

10.3 Second Amendment to Acquisition Agreement dated as of October 25,
2002.

10.4 Debtor in Possession Credit Agreement dated as of September 24, 2002
by and among Peregrine Systems, Inc., Peregrine Remedy, Inc., the
subsidiaries of Borrowers named therein and BMC Software, Inc.