BMC SOFTWARE INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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FORM 10-K

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

FOR THE FISCAL YEAR ENDED MARCH 31, 2003

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 001-16393

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

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

2101 CITYWEST BOULEVARD
HOUSTON, TEXAS
(Address of principal executive offices)

77042-2827
(Zip code)

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

Securities Registered Pursuant to Section 12(b) of the Act:

Securities Registered Pursuant to Section 12(g) of the Act: NONE

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).Yes [X] No [ ]

The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant, based upon the last reported sale price of the
registrant's common stock on September 30, 2002 was $3,074,051,021.

As of June 11, 2003, there were outstanding 228,625,980 shares of common
stock, par value $.01, of the registrant.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the following documents are incorporated by reference in this
report:

Definitive Proxy Statement filed in connection with the registrant's Annual
Meeting of Stockholders currently scheduled to be held on August 21, 2003 (Part
III of this Report)

Such Proxy Statement shall be deemed to have been "filed" only to the
extent portions thereof are expressly incorporated by reference.

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This Annual Report on Form 10-K 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 "Management's Discussion and
Analysis of Results of Operations and Financial Condition -- Certain Risks and
Uncertainties." You should also carefully review the cautionary statements
described in the other documents we file from time to time with the Securities
and Exchange Commission, specifically all Quarterly Reports on Form 10-Q and
Current Reports on Form 8-K. Information contained on our website is not part of
this Annual Report.

PART I

ITEM 1. BUSINESS

OVERVIEW

BMC Software is one of the world's largest independent systems software
vendors, delivering comprehensive enterprise management. Delivering Business
Service Management, we provide software solutions that empower companies to
manage their information technology (IT) infrastructure from a business
perspective. Our extensive portfolio of software solutions spans enterprise
systems, applications, databases and service management. We were organized as a
Texas corporation in 1980 and were reincorporated in Delaware in July 1988. On
November 20, 2002, we acquired the assets and assumed certain liabilities of
Remedy(R). On March 20, 2003, we acquired all the outstanding shares of IT
Masters International S.A. (IT Masters). Our principal corporate offices are
located at 2101 CityWest Boulevard, Houston, Texas 77042-2827. Our telephone
number is (713) 918-8800, and our primary internet address is
http://www.bmc.com.

We file annual, quarterly and current reports, proxy statements and other
information with the Securities and Exchange Commission (SEC). These filings and
all related amendments are available free of charge at our website at
http://www.bmc.com/investors/sec_filings.html. Beginning with this Annual
Report, we will post all of our SEC documents to our website as soon as
reasonably practicable after such material is electronically filed with, or
furnished to, the SEC.

STRATEGY

In April 2003, we introduced a new strategic direction focused on Business
Service Management (BSM), the direct linkage of IT resources, management and
solutions with the goals of the overall business. The objective of our BSM
strategy is to enable companies to move beyond traditional IT management and
manage their business-critical services from both an IT and business
perspective. The intent of the BSM strategy is to provide solutions that will
enable customers to link their IT resources tightly to business objectives and
manage these resources based on business priorities by providing a "whole view"
of their business and IT operations. Three important components of BSM are: 1)
IT Operations and Infrastructure Management, 2) IT Service and Applications
Management and 3) Service Impact Management.

Our long-standing heritage of providing enterprise management solutions for
data, infrastructure, application, performance and service management are key to
the IT Operations and Infrastructure Management component of the BSM strategy.
We provide our customers with the ability to monitor and control the key
components in their IT infrastructure, including systems, databases,
applications, storage and networks, enabling them to tie service-level
agreements to business needs, rather than technology metrics.

We added an important element to our portfolio when we completed our
acquisition of Remedy in November 2002. Integration of Remedy's industry-leading
service desk, change management and asset management capabilities with our broad
application and component management solutions enables us to deliver end-to-end,
closed-loop service management to customers. Together, these solutions build a
solid foundation for the IT Service and Applications Management component of the
BSM strategy by offering both the delivery and support components of service
management designed to be proactive, effective and focused on customer business
requirements.

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An important component of BSM is to directly link business services to the
underlying technology. The acquisition of IT Masters in March 2003 enables us to
deliver the Service Impact Management component of the BSM strategy and enhances
our competitive position in the service management market. IT Masters'
MasterCell(R) technology, renamed PATROL(R) for Service Impact Management,
combines powerful event automation and service modeling capabilities to
transform availability and performance data into detailed knowledge about the
status of business services and service level agreements. Our comprehensive
enterprise and service management solutions, combined with PATROL for Service
Impact Management's IT service modeling and management capabilities, enable
customers to manage their business using a truly integrated service impact
management approach.

Although we believe that we have the most complete BSM offering in the
market today, our BSM strategy will continue to evolve over the next several
years. In addition to adding new solutions that support this strategy, we expect
that we will continue to expand partnerships to deliver on the BSM strategy.

PRODUCTS

Our software products are designed to help our customers proactively and
automatically manage their businesses through comprehensive systems management
solutions. These solutions span enterprise systems, applications, databases and
service management. During fiscal 2003, we managed our business along the
following broad categories: Enterprise Data Management, Enterprise Systems
Management, Service Management and Other Software Solutions. For financial
information related to these product categories, see Note 10 to the accompanying
Consolidated Financial Statements.

Enterprise Data Management

Our Enterprise Data Management solutions provide intelligent, automated
data management tools across all major databases, including IBM's IMS and DB2
for the mainframe environment and Microsoft's SQL Server, IBM's DB2 UDB and
Informix databases and databases from Oracle and Sybase for distributed
computing environments. This segment includes our SmartDBA family of database
management tools which offer highly automated monitoring and diagnostics,
automation of day-to-day management tasks, and fast, reliable database backup
and recovery. These solutions assist customers in lowering their operating
costs and increasing their IT staff productivity by optimizing database
availability as well as ensuring faster rollout of business applications. The
software products in this segment address the following data management needs
of businesses: application performance, database performance, space management,
SQL development, SQL tuning, system performance, database administration,
high-speed utilities and backup and recovery across mainframe and distributed
computing environments. Our Enterprise Data Management solutions contributed
approximately 50%, 45% and 44% of our license revenues in fiscal 2001, 2002
and 2003, respectively.

Enterprise Systems Management

Our Enterprise Systems Management solutions provide software tools for
businesses to proactively and centrally manage their IT infrastructure. A solid
infrastructure connected by a reliable network is the foundation of any
successful business. It is vital to know that a problem exists before it impacts
critical business applications. Accurate infrastructure management ensures that
all components required to deliver quality service to users are under control
and performing at optimal levels. Our solutions in this segment include our
PATROL product line for distributed computing environments, our MAINVIEW(R)
product line for mainframe computing environments and our enterprise job
scheduling and output management solutions. Within this product group, we
provide the following systems management solutions: server management for Unix,
Windows, Linux and mainframe environments, applications management, network
management, enterprise job scheduling, output management, service modeling and
performance and capacity planning. Our Enterprise Systems Management solutions
contributed approximately 43%, 46% and 42% of our license revenues in fiscal
2001, 2002 and 2003, respectively.

Service Management (Remedy)

Remedy, acquired in November 2002, delivers Service Management software
solutions that enable organizations to automate and manage internal and external
service and support processes. Remedy delivers out-of-the-box applications that
help customers align service and support with business objectives, improve
service levels, manage assets and lower costs. All Remedy applications,
including the help desk, asset management, change management, service level
agreement and customer support applications, are built on the highly flexible
Action Request System(R), empowering customers to easily adapt their Service
Management solution to unique and changing requirements. Our Remedy software
solutions contributed approximately 6% of our license revenues in fiscal 2003,
including approximately 12% of license revenues in our fourth fiscal quarter,
its first full quarter of results after the acquisition.

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Other Software Solutions

Our Other Software Solutions primarily include our storage management,
security, enterprise application management, subscription services and Linux
management solutions. Our storage management solutions extend our enterprise
systems management approach to computer storage environments. Our security
administration solutions facilitate user registration and password
administration and thereby enhance and strengthen the overall security of our
customers' information systems. Our enterprise application management solutions
include a comprehensive set of tools and utilities for SAP as well as other ERP
applications. Our subscription services provide remote monitoring of internet
sites and servers on a subscription basis. Our mainframe management tools for
the Linux operating system are also included in this product group. Our Other
Software Solutions contributed approximately 7%, 9% and 8% of our license
revenues in fiscal 2001, 2002 and 2003, respectively.

SALES AND MARKETING

We market and sell our products in most major world markets directly
through our sales force and indirectly through channel partners, including
resellers, distributors and systems integrators. We also have an inside sales
division which provides us a lower-cost channel for additional sales into
existing customers and expands our customer base. In addition, we market certain
of our products online through our webstore located at http://www.bmc.com.

INTERNATIONAL OPERATIONS

Approximately 43%, 42% and 44% of our total revenues in fiscal 2001, 2002
and 2003, respectively, were derived from business outside North America. For
additional financial information regarding our North America and international
operations, see "Management's Discussion and Analysis of Results of Operations
and Financial Condition -- Revenues" and Note 10 to the accompanying
Consolidated Financial Statements. Our international operations primarily
provide sales, sales support, product support, marketing and product
distribution services for our customers located outside of North America. We
also conduct development activities in Israel for our scheduling, security,
output management and ERP products, in France for our network management
products and in Belgium for our service modeling products. Our development
operations in Singapore and Frankfurt, Germany provide local language support,
product internationalization and integration with local-market hardware and
software. Our operations in Pune, India provide internal IT support, new product
development, maintenance and quality assurance for certain products as an
extension of our primary development offices, and we contract with third-party
developers in India. As a global company, we plan to continue to look for
opportunities to efficiently expand our operations in international locations
that offer highly-talented resources as a way to maximize our global
competitiveness.

We believe that our operations outside the United States are located in
countries that are politically stable and that such operations are not exposed
to any special or unusual risks, except for the product development operations
in Israel and the product development and IT operations in India. For a
discussion of various unusual risks associated with Israeli and Indian
operations and investments, see "Management's Discussion and Analysis of Results
of Operations and Financial Condition -- Certain Risks and Uncertainties --
Risks Related to International Operations."

Our growth prospects are highly dependent upon the continued growth of our
international software license and maintenance revenues, and such revenues have
been somewhat unpredictable in the past. Revenues from our foreign subsidiaries
are denominated in local currencies, as are operating expenses incurred in these
locales. To date, we have not had any material foreign currency exchange gains
or losses. For a discussion of our currency hedging program and the impact of
currency fluctuations on international license revenues in fiscal 2002 and 2003,
see "Management's Discussion and Analysis of Results of Operations and Financial
Condition -- Product License Revenue" and Note 1(g) to the accompanying
Consolidated Financial Statements. We have not previously experienced any
difficulties in exporting our products, but no assurances can be given that such
difficulties will not occur in the future.

RESEARCH AND PRODUCT DEVELOPMENT

In fiscal 2001, 2002 and 2003, research, development and support spending,
net of capitalized amounts, represented 29%, 37% and 37% of our total revenues,
respectively. These costs related primarily to the compensation of research and
development personnel and the costs associated with the maintenance, enhancement
and support of our products. Although we develop many of our products
internally, we may acquire technology from third parties when appropriate and
may incur royalty and other payment obligations in connection with such
acquisitions. Traditionally, we have acquired rights from third parties to use
certain technologies that we believed would accelerate development of new
products. Our expenditures on research and development and on product
maintenance,

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enhancement and support, including amounts capitalized, in the last
three fiscal years are discussed below under the heading, "Management's
Discussion and Analysis of Results of Operations and Financial Condition --
Expenses -- Research, Development and Support."

We conduct research and development activities in Houston and Austin,
Texas, Waltham, Massachusetts, San Jose and Mountain View, California, Israel,
France and Belgium, as well as in small offices in other locations around the
world. Product manufacturing and distribution for the Americas are based in
Houston, Texas, and Pleasanton, California, with European manufacturing and
distribution based in Dublin, Ireland, and Asia Pacific manufacturing and
distribution based in Singapore.

MAINTENANCE, ENHANCEMENT AND SUPPORT SERVICES

Revenues from providing maintenance, enhancement and support services
comprised 35%, 45% and 48% of our total revenues in fiscal 2001, 2002 and 2003,
respectively. Payment of maintenance, enhancement and support fees generally
entitles a customer to telephone and Internet support and problem resolution
services, including proactive notification, electronic support requests and a
resolution database, and enhanced versions of products released during the
maintenance period, including new versions necessary to run with the most
current release of the operating systems, databases and other software supported
by the products. Such maintenance fees are an important source of recurring
revenue to us, and we invest significant resources in providing maintenance
services and new product versions. These services are important to our customers
who require immediate problem resolution because of their use of our products to
manage their business-critical IT systems. The services are also necessary
because customers require forward compatibility and enhanced product features
when they install new versions of the software systems supported by one of our
products.

PROFESSIONAL SERVICES

Our professional services group consists of a worldwide team of experienced
software consultants who provide implementation, integration and education
services related to our products. By easing the implementation of our products,
these services help our customers accelerate the time to value. By improving the
overall customer experience, these services also drive future software license
transactions with these customers. Professional services contributed
approximately 6%, 7% and 6% of our revenues for fiscal 2001, 2002 and 2003,
respectively.

PRODUCT PRICING AND LICENSING

Our software solutions are licensed under a variety of license types,
including single tiered computer licenses, enterprise capacity licenses and per
user licenses. Under a tiered computer license, a customer is licensed to use
the product on a single computer and the license fee for a product increases in
relation to the processing capacity of the computer on which the product is
installed. Under an enterprise license, the customer is licensed to use the
product across its enterprise, subject to capacity limits such as the aggregate
processing power of all its computers in the case of products running on
mainframe systems or the number of servers in the case of products running on a
distributed network. Many of our largest customers have entered into enterprise
license agreements. Under a per user license, the customer is licensed to use
the product for a certain number of named users or seats. Under tiered pricing,
computers are classified according to their processing power with more powerful
computers falling into higher tiers and carrying higher license fees. In a
tiered computer license, additional license fees are owed if a product is
installed on a more powerful computer that falls into a higher tier. In an
enterprise license, additional license fees are owed when the licensed capacity
is exceeded. In addition to perpetual licenses, our software solutions are also
licensed, to a lesser degree, under term licenses whereby customers are granted
license rights to a given software product for a defined period of time. Under
both tiered and enterprise licenses, and both perpetual and term licenses, we
negotiate discounts from our list prices for our software solutions, primarily
discounts for multiple copies of a product and volume discounts for enterprise
license transactions.

We recognize revenues from license fees when both parties are legally
obligated under the terms of the respective signed agreement, the underlying
software products have been delivered to and accepted by the customer, the fees
are fixed or determinable, collection is deemed probable and there are no
remaining material obligations on our part. Based on licensing trends and
increased customer requests for contractual terms that result in deferral of
revenue, we expect that our base of deferred license revenue will continue to
grow in the near future. The contract terms and conditions that result in
deferral of revenue recognition for a given transaction result from arm's length
negotiations between us and our customers. During these negotiations, the
contract terms and conditions that result in deferral may be requested by a
customer, while in some cases we may suggest inclusion of these terms and
conditions where it makes business sense to do so. In either case, the resulting
contract must be acceptable to both parties. Once it is determined that license
revenue for a particular contract must be deferred, based on the contractual
terms and application of revenue recognition policies to those terms, the
Company recognizes such license revenue either ratably over the term of the
contract or when

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the revenue recognition criteria are met. For the year ended March 31, 2003,
gross additions to deferred license revenue were $134.6 million. We again expect
a portion of our license revenue in fiscal 2004 to be either deferred until
contingencies are satisfied or recognized ratably due to certain terms and
conditions included in agreements. We recognize maintenance, enhancement and
support revenues, including maintenance bundled with perpetual license fees,
ratably over the maintenance period, and we recognize professional services
revenues as the services are provided. Our revenue recognition policy is
discussed in further detail below under the heading "Management's Discussion and
Analysis of Results of Operations and Financial Condition -- Revenues" and in
Note 1(j) to the accompanying Consolidated Financial Statements.

We make extended payment terms for our products and services available for
qualifying transactions. By providing such financing, we allow our customers to
better manage their IT expenditures and cash flows. Our financing program is
discussed in further detail below under the heading "Management's Discussion and
Analysis of Results of Operations and Financial Condition -- Liquidity and
Capital Resources."

SEASONALITY

As is typical in the software industry, we tend to experience a higher
volume of license transactions and associated revenue in our third and fourth
fiscal quarters as a result of our customers' spending patterns and our internal
sales compensation plans. As a result of this seasonality for license
transactions, we tend to have greater operating cash flow in our first and
fourth fiscal quarters.

COMPETITION

The enterprise management software business is highly competitive, as
discussed below and in the "Management's Discussion and Analysis of Results of
Operations and Financial Condition" section of this report under the heading
"Certain Risks and Uncertainties." There are several companies, including IBM,
Computer Associates and Microsoft, as well as large computer manufacturers such
as Sun Microsystems and Hewlett Packard, which have substantially greater
resources than we have, as well as the ability to develop and market enterprise
management solutions similar to and competitive with the solutions offered by
us. In addition, there are numerous independent software companies that compete
with one or more of our software solutions. Although no company competes with us
across our entire software solution line, we consider at least 70 firms to be
directly competitive with one or more of our enterprise software solutions.
Certain of these companies have substantially larger operations than ours in
these specific niches.

Certain of our solutions in the Enterprise Data Management product group
compete directly with IBM, primarily with IBM's IMS and DB2 database management
systems, and its IMS/TM and CICS transaction managers. Some of our solutions,
including our core IMS and DB2 database tools and utilities, are essentially
improved versions of system software utilities that are provided as part of
these integrated IBM system software products. IBM also markets separately
priced competing utilities in addition to its base utilities. 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 continues to invest 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 would be
materially adversely affected. To date, our solutions have competed well against
IBM's because we have developed advanced automation and artificial intelligence
features and our utilities have maintained a speed advantage. In addition, we
believe that because we provide enterprise management solutions across multiple
platforms we are better positioned to provide customers with comprehensive
management solutions for their complex multi-vendor IT environments than
integrated hardware and software companies like IBM.

We believe that the key criteria considered by potential purchasers of our
products are as follows: operational advantages and cost savings provided;
expected return on investment; product quality and capability; product price and
the terms on which the product is licensed; ease of integration of the product
with the purchaser's existing systems; ease of product installation and use;
quality of support and product documentation; and the experience and financial
stability of the vendor.

CUSTOMERS

No single customer accounted for a material portion of our revenues during
any of the past three fiscal years. Our software products are generally used in
a broad range of industries, businesses and applications. Our customers include
manufacturers, telecommunications companies, financial service providers,
educational institutions, retailers, distributors, hospitals, service providers,
government agencies and value-added resellers.

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INTELLECTUAL PROPERTY

We distribute our products in object code form and rely upon contract,
trade secret, copyright and patent laws to protect our intellectual property.
The license agreements under which customers use our products restrict the
customer's use to its own operations and prohibit disclosure to third persons.
We distribute certain of our products on a shrink-wrap basis, and the
enforceability of such restrictions in a shrink-wrap license is unproven in
certain jurisdictions. Also, notwithstanding those restrictions, it is possible
for other persons to obtain copies of our products in object code form. We
believe that obtaining such copies would have limited value without access to
the product's source code, which we keep highly confidential. In addition, we
employ protective measures such as CPU dependent passwords, expiring passwords
and time-based trials.

EMPLOYEES

As of March 31, 2003, we had 6,861 full-time employees. We believe that our
continued success will depend in part on our ability to attract and retain
highly skilled technical, sales, marketing and management personnel.

ITEM 2. PROPERTIES

Our headquarters and principal marketing and product development operations
are located in Houston, Texas, where we own four office buildings totaling
approximately 1,515,000 square feet. We also maintain development and sales
organizations in various locations around the world where we lease the necessary
facilities, none of which are significant individually or in the aggregate.

ITEM 3. LEGAL PROCEEDINGS

On January 29, 2003, we filed a complaint against NetIQ Corporation (NetIQ)
in the United States District Court of the Southern District of Texas, Houston
Division, alleging that one or more of NetIQ's software products and their use
infringe a valid U.S. patent and that Net IQ infringed one or more trademarks
held by us. BMC Software seeks to enjoin NetIQ's current and future infringement
of our patent and trademarks and to recover compensatory damages and punitive
damages, interest, costs and fees.

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

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not Applicable.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock is listed on the New York Stock Exchange and trades under
the symbol BMC. At June 11, 2003, there were 1,560 holders of record of our
common stock.

The following table sets forth the high and low intra-day sales prices per
share of common stock for the periods indicated.

We have never declared or paid dividends to BMC Software stockholders. We
do not intend to pay any cash dividends in the foreseeable future. We currently
intend to retain any future earnings otherwise available for cash dividends on
the common stock for use in our operations, for expansion and for stock
repurchases. See "Management's Discussion and Analysis of Results of Operations
and Financial Condition -- Liquidity and Capital Resources."

ITEM 6. SELECTED FINANCIAL DATA

The following selected consolidated financial data presented under the
captions "Statement of Operations Data" and "Balance Sheet Data" for, and as of
the end of, each of the years in the five-year period ended March 31, 2003, are
derived from the Consolidated Financial Statements of BMC Software, Inc. and its
subsidiaries. The following acquisitions during the five-year period ended March
31, 2003 were accounted for under the purchase method and, accordingly, the
financial results of these acquired companies have been included in our
financial results below from the indicated acquisition dates: New Dimension
Software Ltd. in April 1999, Evity, Inc. (Evity) in April 2000, OptiSystems
Solutions Ltd. (OptiSystems) in August 2000, Remedy in November 2002 and IT
Masters in March 2003.

Prior to April 1, 2002, we were amortizing our acquired goodwill and
intangible assets over three to five-year periods, which reflected the estimated
useful lives of the respective assets. As of April 1, 2002, we adopted Statement
of Financial Accounting Standards (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. Note 5 to the accompanying
Consolidated Financial Statements includes a reconciliation of our reported net
earnings (loss) and earnings (loss) per share for the years ended March 31, 2001
and 2002 to those amounts that would have resulted had there been no
amortization of goodwill and intangible assets with indefinite lives for those
periods. Note 5 to the accompanying Consolidated Financial Statements also
discusses impairment charges recorded during the year ended March 31, 2002
related to goodwill and acquired technology which materially impacted the
results for that year below.

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The consolidated financial statements for fiscal 1999 through fiscal 2001
have been audited by Arthur Andersen LLP, independent public accountants. The
consolidated financial statements for fiscal 2002 and fiscal 2003 have been
audited by Ernst & Young LLP, independent auditors. The selected consolidated
financial data should be read in conjunction with the Consolidated Financial
Statements as of March 31, 2002 and 2003, and for each of the three years in the
period ended March 31, 2003, the accompanying notes and the reports of
independent public accountants and independent auditors thereon, which are
included elsewhere in this Form 10-K.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION

INTRODUCTION

This section includes historical information, certain forward looking
information and the information provided below under the heading "Certain Risks
and Uncertainties" about certain risks and uncertainties that could cause our
future operating results to differ materially from the results indicated by any
forward looking statements made by us or others. It is important that the
business discussion in Item 1 of this report and the historical discussion below
be read together with the discussion of risks and uncertainties, and that these
discussions be read in conjunction with the accompanying Consolidated Financial
Statements and notes thereto.

CRITICAL ACCOUNTING POLICIES

The preparation of 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 make and evaluate estimates and
judgments, including those related to revenue recognition, capitalized software
development costs, in-process research and development of acquired businesses,
acquired technology, 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 Management's Discussion and Analysis of Financial
Condition and Results of Operations where such policies affect our reported and
expected financial results.

HISTORICAL INFORMATION

Historical performance should not be viewed as indicative of future
performance, as there can be no assurance that operating income (loss) or net
earnings (loss) as a percentage of revenues will be sustained at these levels.
For a discussion of factors affecting operating margins, see the discussions
below under the heading "Certain Risks and Uncertainties."

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ACQUISITIONS

In April 2000, we acquired Evity for 1.6 million shares of common stock and
cash of $10.0 million. Stock options to purchase 0.4 million common shares were
issued to replace outstanding Evity stock options. In August 2000, we acquired
OptiSystems for cash of $70.2 million. In November 2002, we acquired the assets
of Remedy from Peregrine Systems, Inc. (Peregrine) for cash of $355.0 million
plus the assumption of certain liabilities of Remedy. In accordance with the
purchase agreement, the cash purchase price was adjusted to $347.3 million
subsequent to March 31, 2003. In March 2003, we acquired IT Masters for cash of
$42.5 million. These transactions, along with various other immaterial
technology acquisitions, were accounted for using the purchase accounting method
and accordingly, the financial results for these entities have been included in
our consolidated financial results since the applicable acquisition dates.

RESULTS OF OPERATIONS

The following table sets forth, for the fiscal years indicated, the
percentages that selected items in the accompanying Consolidated Statements of
Operations and Comprehensive Income (Loss) bear to total revenues.

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 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 or determinable, and determination that collection of the
software license fees is probable. In instances when any one of the four
criteria is 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,

9

distributors and resellers are recorded either at the gross amount charged the
customer or net of commissions payable, 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. Our professional services revenues also include
sales of third-party software products which typically support our product
lines. These revenues are recorded net of amounts payable to the third-party
software vendors.

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. 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.

Total revenues declined 15% in fiscal 2002. Continued absorption of prepaid
capacity and difficult economic conditions in domestic and international markets
throughout fiscal 2002 resulted in reduced information technology spending by
many of our customers. Though the number of license transactions declined only
4% during fiscal 2002 as compared to fiscal 2001, tighter budgets and higher
required approval levels caused many customers to enter into smaller
transactions in terms of dollar value. Difficult economic conditions have
persisted and information technology spending remains depressed. We have
experienced a decline in the size of transactions with our largest customers,
which historically have accounted for a significant portion of our revenues.
As discussed in Note 2 to the accompanying Consolidated Financial Statements,
we acquired Remedy in November 2002. Excluding the impact of Remedy revenues
subsequent to the acquisition date, total revenues declined 3% in fiscal 2003
primarily as a result of the economic conditions described above and reduced
revenues for our PATROL solutions during the first half of fiscal 2003, as
discussed below under Product Line Revenues. License revenue deferrals for
fiscal 2003 were consistent with fiscal 2002 and therefore did not have an
impact on the revenue change from year to year. Including Remedy revenues
subsequent to the acquisition date, total revenues increased 3%. Product revenue
growth was not materially impacted by inflation in fiscal 2002 and 2003.

10

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 additional computing capacity or by additional users. In addition to
perpetual-based product license fees, our product 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 defined period of time.

For the year ended March 31, 2003, gross additions to deferred license
revenue were $134.6 million. Based on licensing trends and increased customer
requests for contractual terms that result in deferral of revenue, we expect
that our base of deferred license revenue will continue to grow in the near
future. The contract terms and conditions that result in deferral of revenue
recognition for a given transaction result from arm's length negotiations
between us and our customers. During these negotiations, the contract terms and
conditions that result in deferral may be requested by a customer, while in some
cases we may suggest inclusion of these terms and conditions where it makes
business sense to do so. In either case, the resulting contract must be
acceptable to both parties. Once it is determined that license revenue for a
particular contract must be deferred, based on the contractual terms and
application of revenue recognition policies to those terms, the Company
recognizes such license revenue either ratably over the term of the contract or
when the revenue recognition criteria are met. Because of this, we generally
know the timing of the subsequent recognition of license revenue at the time of
deferral. Therefore, the amount of license revenue to be recognized out of the
deferred revenue balance in each future quarter is predictable, and our total
license revenues to be recognized each quarter become more predictable as a
larger percentage of those revenues come from the deferred balance. As of March
31, 2002 and 2003, our total deferred license revenue balance was $168.9 million
and $218.1 million, respectively.

Our North American operations generated 54%, 56% and 54% of total license
revenues in fiscal 2001, 2002 and 2003, respectively. North American license
revenues decreased 27% from fiscal 2001 to fiscal 2002 and 7% from fiscal 2002
to fiscal 2003. Excluding the impact of Remedy revenues subsequent to the
acquisition date, North American license revenues declined 13% in fiscal 2003.
While license revenues were down across most product groups in fiscal 2002 and
fiscal 2003, the largest contributor to the revenue declines in both years was
decreased license revenues for our mainframe data management products. In fiscal
2003, decreased PATROL license revenues also had a significant impact.

International license revenues represented 46%, 44% and 46% of total
license revenues in fiscal 2001, 2002 and 2003, respectively. International
license revenues decreased 33% from fiscal 2001 to fiscal 2002 and increased 2%
from fiscal 2002 to fiscal 2003. While license revenues were down across most
product groups from fiscal 2001 to fiscal 2002, decreased license revenues for
our mainframe data management products were the largest contributor to the
revenue decline for the year. Excluding the impact of Remedy revenues subsequent
to the acquisition date, international license revenues declined 4% in fiscal
2003. Increases in license revenue for our mainframe data management and
MAINVIEW products were more than offset by declines for our PATROL, distributed
systems data management and scheduling and output management products. The
international license revenue decline for fiscal 2002 included a decrease of 2%
and the decline in fiscal 2003 was net of an increase of 6% due to foreign
currency exchange rate changes during the periods, after giving effect to our
foreign currency hedging program.

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
generally entitles customers to product enhancements, technical support services
and ongoing compatibility with third-party operating systems, database
management systems, networks, storage systems and applications. Excluding
Remedy, these fees are generally charged annually and such fees 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, and have equaled 20% subsequent
to the program change. 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. Remedy's maintenance fees are generally charged
annually and equal 15% to 22% of the list price of the product. In addition,
customers may be entitled to reduced maintenance percentages on Remedy products
for entering into long-term maintenance contracts that include prepayment of the
maintenance fees.

11

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 has been a negative
short-term revenue impact. As discussed above, this maintenance program does not
apply to Remedy products.

Maintenance revenues increased 10% in both fiscal 2002 and 2003 primarily
as a result of the continuing growth in the base of installed products and the
processing capacity on which they run and the additional maintenance revenue
associated with Remedy. Excluding the impact of Remedy revenues subsequent to
the acquisition date, maintenance revenues increased 5% in fiscal 2003.
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 excluding Remedy. Further declines in our license
revenue and/or increased discounting could lead to declines in our maintenance
revenues excluding Remedy. Historically, our maintenance renewal rates have been
high, but economic pressures could cause customers to reduce their licensed
capacity and therefore the capacity upon which our maintenance, enhancement and
support fees are charged.

We expect Remedy maintenance revenues to increase over the next fiscal
year. As required by purchase accounting for the acquisition, the Remedy
deferred maintenance revenue at the acquisition date was written down to fair
value, as defined by U.S. generally accepted accounting principles. As such, the
amounts recognized as maintenance revenue out of that acquisition-date deferred
revenue balance will reflect this write-down. The vast majority of the
acquisition-date deferred revenue will be recognized during the 12 months
following the acquisition. All maintenance fees generated subsequent to the
acquisition date will be deferred and recognized over the maintenance period at
full contractual amounts.

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 recent acquisition of Remedy extends our solutions to include
products that automate service-related business processes through a complete
suite of service management applications. In fiscal 2003, our solutions were
broadly divided into three core business units and a fourth business unit geared
towards solution areas in markets that appear to offer high growth
opportunities. The Enterprise Data

12

Management group includes products designed for managing database management
systems on mainframe and distributed computing platforms. The Enterprise Systems
Management group includes our systems management and monitoring, scheduling and
output management solutions. The Remedy group includes our service management
solutions. The High Potential product lines encompass storage management,
security management, enterprise applications management, subscription services
and Linux management. We evaluate our investments in these product lines on an
ongoing basis and increase or decrease such investments as necessary, based on
our expectations of the products' future growth.

Our Enterprise Data Management solutions combined represented 53%, 48% and
45% of total software revenues for fiscal 2001, 2002 and 2003, respectively.
Total software revenues for this group declined 23% from fiscal 2001 to fiscal
2002 and 4% from fiscal 2002 to fiscal 2003. Because this product group includes
a high proportion of mainframe solutions, the continued absorption of prepaid
capacity and the external market factors discussed above were the primary cause
of the decline in license revenues in fiscal 2002, more than offsetting an
increase in maintenance revenue for that year. In fiscal 2003, the economic
conditions discussed above caused both license and maintenance revenues for our
mainframe data management products to decline, more than offsetting an increase
in maintenance revenue for our distributed systems data management products. The
maintenance revenue decline was primarily a result of lower discounted prices
and slowing capacity growth, which was not sufficient to offset these reduced
prices.

Our Enterprise Systems Management solutions combined contributed 41%, 44%
and 42% of total software revenues for fiscal 2001, 2002 and 2003, respectively.
Total software revenues for this group declined 9% from fiscal 2001 to fiscal
2002 and 1% from fiscal 2002 to fiscal 2003. In fiscal 2002, license revenue
decreases for this product group, due to the economic factors discussed above,
more than offset maintenance revenue increases. License revenues decreased in
fiscal 2003 primarily due to the continued weakness in IT spending and a
reduction in Unix shipments from hardware manufacturers. 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
during the first half of the year, 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 for the PATROL and Scheduling & Output Management solutions.
The remaining key PATROL enhancements were delivered at the end of the third
quarter of fiscal 2003. Though PATROL license revenues were down for the second
half of the year compared to the same period in fiscal 2002, such revenues for
the third and fourth quarters increased sequentially over the immediately
preceding quarters. These increases were due, in part, to sales from the
newly-introduced agentless monitoring product, PATROL Express(R).

Our High Potential product lines contributed 5%, 7% and 7% of total
software revenues for fiscal 2001, 2002 and 2003, respectively. Total software
revenues for this group increased 16% from fiscal 2001 to fiscal 2002 and 3%
from fiscal 2002 to fiscal 2003. Fiscal 2002 growth includes revenue increases
across all product lines. However, license revenue for our High Potential
products declined in fiscal 2003. 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. As of April
1, 2003, we have decided from an organizational perspective to eliminate the
High Potential product lines as standalone units and to combine the storage
management, enterprise application management, subscription services and Linux
management product lines into the core Enterprise Systems Management business
unit. The security product group will continue to operate as an independent
business unit and currently has a dedicated sales force in North America. We
have also made changes related to the storage management product line, from a
go-to-market perspective. Our mainframe storage management and storage device
knowledge modules remain key components of our systems management solutions;
however, we have decided to limit our future research and development investment
in one product, PATROL Storage Manager, to supporting the existing version of
this product. This decision is based on our focus on improving profit margins
and allocating resources to more attractive opportunities.

Revenues from our Remedy products for the period from the acquisition date
of November 20, 2002 through March 31, 2003, contributed 6% of total software
revenues for fiscal 2003, including 13% of total software revenues in our fourth
fiscal quarter, its first full quarter of results after the acquisition,
including the impact of the write-down of the acquisition date deferred
maintenance revenue discussed above.

PROFESSIONAL SERVICES REVENUES

Professional services revenues, representing fees from implementation,
integration and education services performed during the periods and sales of
third-party software products, represented 6%, 7% and 6% of total revenues,
respectively, for fiscal 2001, 2002 and 2003. Professional services revenues
declined 6% from fiscal 2001 to fiscal 2002 and 3% from fiscal 2002 to fiscal
2003. Excluding the impact of Remedy revenues subsequent to the acquisition
date, professional services revenues declined 7%. The declines in both years are
the result of our decreased license revenues, as this results in less demand for
our implementation and integration services. Our professional services headcount
has decreased due to the lower license revenue levels.

13

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. This initiative has continued throughout fiscal 2003 and will
continue into the future, as necessary.

SELLING AND MARKETING

Our selling and marketing expenses include personnel and related costs,
sales commissions and costs associated with advertising, industry trade shows
and sales seminars, and represented 40%, 42% and 38% of total revenues in fiscal
2001, 2002 and 2003, respectively. Selling and marketing expenses decreased 10%
from fiscal 2001 to fiscal 2002 and 7% from fiscal 2002 to fiscal 2003.
Excluding the impact of Remedy expenses subsequent to the acquisition date,
selling and marketing expenses declined 12%. Personnel costs were the largest
contributor to the expense declines in fiscal 2002 and 2003 as a result of
headcount reductions during those years. Consulting fees and travel costs also
declined in fiscal 2002 and advertising, marketing and travel costs decreased in
fiscal 2003.

RESEARCH, DEVELOPMENT AND SUPPORT

Research, development and support 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, development and support costs were reduced in all three fiscal
years 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 economic lives, which historically have been
five years. As discussed below, we revised the estimated economic lives for
certain of our software products as of January 1, 2003, such that the
capitalized costs for the majority of our products will be amortized over an
estimated life of three years. Total capitalized software development costs, net
of amortization, at March 31, 2003, were $192.7 million. Under SFAS No. 86, we
evaluate our capitalized software costs at each balance sheet date to determine
if the unamortized balance related to any given product exceeds the estimated
net realizable value of that product. Any such excess is written off through
accelerated amortization in the quarter it is identified. Determining net
realizable value as defined by SFAS No. 86 requires that we make estimates and
use judgment in quantifying the appropriate amount to write off, if any. Actual
amounts realized from the software products could differ from our estimates.
Also, any future changes to our product portfolio could result in significant
research, development and support expenses related to software asset write-offs.

14

The following table summarizes the amounts capitalized and amortized during
fiscal 2001, 2002 and 2003. 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.

As a result of the changes in market conditions and research and
development headcount reductions during fiscal 2002 and fiscal 2003, we focused
more on our core and high-potential growth businesses. As part of this effort,
we reviewed our product portfolio during fiscal 2002 and fiscal 2003 and
discontinued certain products. To the extent that there were any capitalized
software development costs remaining on the balance sheet related to these
products, we accelerated the amortization to write these balances off. This was
the primary reason for the increase in accelerated amortization in fiscal 2002
and 2003 as compared to fiscal 2001. The continued need to accelerate
amortization to maintain our capitalized software costs at net realizable value,
the results of the valuation performed for the Remedy acquisition that indicated
a three-year life was appropriate for that acquired technology and changes in
the average life cycles for certain of our software products caused us to
evaluate the estimated economic lives for our internally developed software
products. As a result of this evaluation, we revised the estimated economic
lives of certain products as of January 1, 2003, such that most products will be
amortized over an estimated life of three years. These changes in estimated
economic lives resulted in an additional $12.4 million of amortization expense
in the fourth quarter of fiscal 2003, and reduced basic and diluted earnings per
share for the year ended March 31, 2003 by $0.03 per share.

Research, development and support expenses increased 8% from fiscal 2001 to
fiscal 2002 primarily due to the net effect of software cost capitalization and
amortization, including the accelerated amortization discussed above, and a $5.0
million write-off of prepaid royalties and other assets related to technology we
no longer plan to utilize. These additional expenses more than offset reduced
headcount costs, travel costs and consulting fees during the period. Research,
development and support expenses increased 2% from fiscal 2002 to fiscal 2003.
Excluding the impact of Remedy expenses subsequent to the acquisition date,
research, development and support expenses decreased 2% primarily as a result of
reductions in personnel, professional fees and royalty costs which more than
offset the net effect of software cost capitalization and amortization detailed
above.

During fiscal 2002, we also wrote off software assets totaling $14.9
million associated with certain business information integration products that
were discontinued during the year as a result of the dissolution of that
business unit as part of our restructuring plan. This charge is included in
restructuring costs in the accompanying Consolidated Statement of Operations and
Comprehensive Income (Loss) for fiscal 2002 and is discussed further below under
the heading "-- Restructuring 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. Cost of professional services decreased 6% from fiscal 2001 to fiscal
2002 and 9% from fiscal 2002 to fiscal 2003. Excluding the impact of Remedy
expenses subsequent to the acquisition date, cost of professional services
declined 13%. The declines in both years resulted primarily from headcount
reductions during these periods as a result of the declines in professional
services revenues.

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. The 8% decline in general and administrative expenses in
fiscal 2002 was primarily related to decreased personnel costs, travel costs and
bad debt expense. General and administrative expenses declined 1% from fiscal
2002 to fiscal 2003. Excluding the impact of Remedy expenses subsequent to the
acquisition date, general and administrative expenses decreased 8% primarily as
a result of reduced bad debt expense, legal fees and shipping costs, which more
than offset increases in personnel, insurance and travel costs.

15

ACQUIRED RESEARCH AND DEVELOPMENT

In executing our product strategies, we employ both internal research and
development and the acquisition of emerging technologies and established
software companies. We believe that time-to-market is critical to our success in
the rapidly evolving distributed systems software market, where we must compete
with a variety of software vendors, and where our products must integrate with
the predominant database management systems, operating systems, network
protocols and applications within the enterprise computing environment.
Accordingly, we must continuously evaluate whether it is more efficient and
effective to develop a given solution internally or acquire a technology that
must be completed and then integrated into our existing product architecture.
The acquired technology companies are often small software companies with
minimal to no revenues, quality and documentation standards and name recognition
in the marketplace. This strategy involves a high degree of risk and is costly
in that a premium is typically paid for software code that is incomplete and
only partially contributes to our overall development plans.

The following table presents information concerning the purchase price
allocations for the acquisitions accounted for under the purchase method for
fiscal 2001, 2002 and 2003.

On April 25, 2000, we acquired all of the outstanding shares of Evity in a
transaction accounted for as a purchase. The aggregate purchase price totaled
$67.3 million, including cash consideration of $10.0 million, 1.0 million shares
of common stock, 0.4 million common stock options and transaction costs, and was
allocated as follows: $2.5 million to acquired technology, $57.8 million to
goodwill and other intangibles and $7.0 million (10% of the purchase price) to
purchased in-process research and development (IPR&D). Net tangible assets
acquired were insignificant. The amount allocated to purchased IPR&D represents
the estimated fair value, based on risk-adjusted cash flows, related to Evity's
research and development projects not yet completed. At the date of acquisition,
the development of these projects had not yet reached technological feasibility,
and the research and development in progress had no alternative future uses.
Accordingly, these costs were expensed as of the acquisition date, during the
quarter ended June 30, 2000.

At the acquisition date, Evity was conducting design, development,
engineering and testing activities associated with the completion of SiteAngel
2.0, an enhanced version of Evity's SiteAngel website performance monitoring
product, as well as new technologies in the areas of load testing and network
infrastructure. The projects under development at the valuation date represented
next-generation technologies that were expected to address emerging market
demands for the web performance market.

At the acquisition date, the technologies under development were
approximately 45% complete based on engineering man-month data and technological
progress. Evity had incurred nearly $1.0 million on the in-process projects and
expected to spend approximately $1.3 million to complete all phases of the
research and development. Anticipated completion dates ranged from 4 to 18
months, at which times we expected to begin benefiting from the developed
technologies. We completed SiteAngel 2.0 during fiscal 2001 and project costs
were materially consistent with management's estimates at the acquisition date.
Also during fiscal 2001, the remaining projects in-process at the acquisition
date were suspended indefinitely.

On August 8, 2000, we acquired all of the outstanding shares of OptiSystems
in a transaction accounted for as a purchase. The aggregate purchase price
totaled $71.5 million in cash, including transaction costs, and was allocated as
follows: $6.3 million to acquired technology, $55.2 million to goodwill and
other intangibles, $4.0 million to equipment, receivables and other non-software
assets, net of liabilities assumed, and $6.0 million (8% of the purchase price)
to purchased in-process research and development. The amount allocated to
purchased IPR&D represents the estimated fair value, based on risk-adjusted cash
flows, related to OptiSystems' incomplete research and development projects. At
the date of acquisition, the development of these projects had not yet reached

16

technological feasibility, and the research and development in progress had no
alternative future uses. Accordingly, these costs were expensed as of the
acquisition date, during the quarter ended September 30, 2000.

At the acquisition date, OptiSystems was conducting design, development,
engineering and testing activities associated with the completion of several
components of its Energizer(R) for R/3 product. The projects under development
at the valuation date represented next-generation technologies that were
expected to address emerging market demands for the enterprise application
performance market.

At the acquisition date, the technologies under development were
approximately 50% complete based on engineering man-month data and technological
progress. OptiSystems had incurred approximately $1.0 million on the in-process
projects, and expected to spend approximately $1.2 million to complete all
phases of the research and development. Anticipated completion dates ranged from
2 to 11 months, at which times we expected to begin benefiting from the
developed technologies. The projects have been completed and project costs were
materially consistent with management's estimates at the acquisition date.

We completed other immaterial acquisitions during fiscal 2001 and 2002
which were accounted for under the purchase method as indicated in the table
above.

On November 20, 2002, we acquired the assets of Remedy from Peregrine for
$355.0 million in cash plus the assumption of certain liabilities of Remedy. In
accordance with the purchase agreement, the cash purchase price was adjusted to
$347.3 million subsequent to March 31, 2003. The aggregate purchase price was
$356.8 million, including the adjusted cash consideration and direct costs of
the transaction. The allocation of the purchase price to specific assets and
liabilities was based, in part, upon outside appraisals of the fair value of
certain assets of Remedy. The following table summarizes the estimated fair
values of the assets acquired and liabilities assumed at the date of
acquisition.

Of the $176.0 million of acquired intangible assets, we allocated $12.0
million (3% of the purchase price) to in-process research and development
projects. The amount allocated represents the estimated fair value, based on
risk-adjusted cash flows and historical costs expended, related to Remedy's
incomplete research and development projects. At the date of acquisition, the
development of these projects had not yet reached technological feasibility, and
the research and development in progress had no alternative future uses.
Accordingly, these costs were expensed as of the acquisition date, during the
quarter ended December 31, 2002.

At the acquisition date, Remedy was conducting design, development,
engineering and testing activities associated with the completion of
next-generation core and application technologies that are expected to address
emerging market demands in the service management market. At the acquisition
date, the technologies under development were approximately 25%-35% complete
based on engineering man-month data and technological progress. Remedy had
incurred nearly $6 million on the in-process projects, and expected to spend
approximately $16 million to complete all phases of the research and
development. Anticipated completion dates ranged from 3 to 12 months, at which
times we expect to begin benefiting from the developed technologies.

On March 20, 2003, we acquired all of the outstanding shares of IT Masters
in a transaction accounted for as a purchase. The aggregate purchase price
totaled $43.3 million in cash, including transaction costs, and was allocated as
follows: $11.2 million to acquired technology, $34.8 million to goodwill and
other intangibles, and $2.7 million to liabilities assumed, net of tangible
assets acquired. At the acquisition date, there were no projects that had
progressed to a degree that would enable the fair value of the in-process
research and development to be estimated with reasonable reliability and
therefore no value was allocated to IPR&D.

In making the purchase price allocations to IPR&D, we considered present
value calculations of income, analyses of project accomplishments and remaining
outstanding items, assessments of overall contributions, as well as project
risks. The values assigned to purchased in-process technology were determined by
estimating the costs to develop the acquired technology into commercially viable
products, estimating the resulting net cash flows from the projects, and
discounting the net cash flows to their present value.

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The revenue projections used to value the in-process research and development
were based on estimates of relevant market sizes and growth factors, expected
trends in technology, and the nature and expected timing of new product
introductions by us and our competitors. The resulting net cash flows from such
projects are based on our estimates of cost of sales, operating expenses and
income taxes from such projects.

In the present value calculations, aggregate revenues for the Evity,
OptiSystems and Remedy developed, in-process and future products were estimated
to grow at compounded annual growth rates of approximately 155%, 43% and 15%,
respectively, for the five years following acquisition, assuming the successful
completion and market acceptance of the major current and future research and
development programs. The estimated revenues for the in-process projects were
expected to peak within three years of acquisition and then decline sharply as
other new products and technologies are expected to enter the market.

The rates utilized to discount the net cash flows to their present value
were based on cost of capital calculations and venture capital rates of return.
Due to the nature of the forecasts and risks associated with the projected
growth and profitability of the developmental projects, discount rates of 25% to
45% were used to value the acquired IPR&D for the various acquisitions during
fiscal 2001, 2002 and 2003. Specifically, discount rates of 30%, 25% and 40% to
45% were used to value the acquired IPR&D for Evity, OptiSystems and Remedy,
respectively. These discount rates were commensurate with the respective stage
of development and the uncertainties in the economic estimates described above.

The assumptions used in valuing IPR&D were based upon assumptions believed
to be reasonable but which are inherently uncertain and unpredictable.
Assumptions may be incomplete or inaccurate, and unanticipated events and
circumstances may occur. Accordingly, actual results may differ from the
projected results used to determine fair value.

The IPR&D charge for fiscal 2001 also includes the write-off of assets
totaling $4.7 million related to a technology agreement with Envive Corporation
that was terminated during the first quarter of fiscal 2001.

AMORTIZATION AND IMPAIRMENT 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. See Note
5 to the accompanying Consolidated Financial Statements 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. We assigned
our goodwill to the applicable reporting units and tested it for impairment upon
adoption of SFAS No. 142 as of April 1, 2002, and as of January 1, 2003 for the
required annual testing. The fair value of each of our 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 either date.

During fiscal 2002, we performed an assessment of the carrying values of
our acquired technology, goodwill and intangibles recorded in connection with
various acquisitions. The assessment was performed because sustained negative
economic conditions impacted our operations and expected future revenues.
Economic indicators at that time suggested that such conditions could continue
for the foreseeable future. As a result, we recorded impairment charges of $15.5
million related to acquired technology to reflect these assets at their then
current estimated net realizable values and $47.8 million related to goodwill to
reflect these assets at their then current estimated fair values. These charges
are reflected together with amortization expense in the accompanying
Consolidated Statements of Operations and Comprehensive Income (Loss) for fiscal
2002, as amortization and impairment of acquired technology, goodwill and
intangibles.

We evaluated our acquired technology under the provisions of SFAS No. 86,
our other intangibles under the provisions of SFAS No. 121, "Accounting for the
Impairment of Long-lived Assets and of Long-lived Assets to be Disposed Of," and
our enterprise-level goodwill under the provisions of Accounting Principles
Board (APB) Opinion No. 17, "Intangible Assets." The impairment charges for
acquired technology reflect the amounts by which the carrying values exceeded
the estimated net realizable values of the products. The net realizable values
for acquired technology were estimated as the future gross revenues from the
products reduced by the estimated future costs of completing and disposing of
the products, including the costs of performing maintenance and customer support
required to satisfy our responsibilities set forth at the time of sale. The
impairment charges for goodwill reflect the amounts

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by which the carrying values exceeded the estimated fair values of these assets.
Fair value was determined by discounting estimated future net cash flows related
to these assets. No impairment was identified for our other intangible assets.
Impairment charges by asset category were as follows:

We review the realizability of acquired technology, goodwill and
intangibles on an ongoing basis, and when there is an indication of impairment,
we perform the procedures under the applicable accounting pronouncements to
quantify any impairment that exists. Determining the amount of impairment of
these assets, if any, requires that we estimate future cash flows and make
judgments regarding discount rates and other variables that impact the net
realizable value or fair value of those assets, as applicable. Actual future
cash flows and other assumed variables could differ from our estimates. Future
impairment charges could be material.

RESTRUCTURING COSTS

During fiscal 2002, we implemented a restructuring plan to better align our
cost structure with existing market conditions. This plan included the
involuntary termination of 1,260 employees during the year. These actions were
across all divisions and geographies and the affected employees received cash
severance packages. During fiscal 2002, we also discontinued certain business
information integration products as a result of the dissolution of that business
unit, and announced the closure of certain locations throughout the world. A
charge of $52.9 million was recorded during fiscal 2002 for employee severance,
the write-off of software assets related to discontinued products, net of
proceeds from the sale of a portion of the related technology, and office
closures.

During fiscal 2002, we sold our enterprise data propagation (EDP)
technology for a minority equity investment in the purchaser and future cash
payments to be made based on the purchaser's quarterly sales to our former EDP
customers over the following four years. As these products were part of the
discontinued business information integration products, the proceeds will be
recorded as a reduction of restructuring costs, as a recovery of the amount
previously written off for these products. For fiscal 2002, proceeds of $0.2
million were recorded, reflecting the estimated fair value of the equity
investment received. As the future cash payments, if any, cannot be estimated,
they will be recorded in the periods received as a reduction of restructuring
costs up to the amount previously written off. Any receipts in excess of the
related asset write-off will be reflected as other income.

As of March 31, 2002, $2.6 million of severance and facilities costs
related to actions completed under the restructuring plan remained accrued for
payment in future periods, as follows:

The $0.1 million credit to restructuring costs recorded during fiscal 2003
is primarily related to the net effect of adjustments to facilities and
severance accruals initially recorded during fiscal 2002. As of March 31, 2003,
substantially all disbursements related to the fiscal 2002 restructuring plan
have been paid.

MERGER-RELATED COSTS AND COMPENSATION CHARGES

During fiscal 2001, 2002 and 2003, we recorded merger-related compensation
charges of $11.4 million, $13.2 million and $0.6 million, respectively. These
compensation charges 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.

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Also during fiscal 2001 and 2002, $2.8 million and $0.4 million,
respectively, of previously accrued merger costs related to the Boole merger
were reversed, as certain lease and severance obligations were satisfied at
amounts below the amounts originally estimated. These reversals are reflected as
a reduction of merger-related costs and compensation charges in the accompanying
Consolidated Statements of Operations and Comprehensive Income (Loss) for fiscal
2001 and 2002.

OTHER INCOME, NET

Other income, net consists primarily of interest earned on cash, cash
equivalents, marketable securities and finance receivables, gains and losses on
marketable securities and other investments and interest expense on short-term
borrowings. Other income, net decreased 23% from fiscal 2001 to fiscal 2002 and
decreased 9% from fiscal 2002 to fiscal 2003. Other income for fiscal 2001
includes a $2.9 million one-time gain related to the sale of a financial
instrument and a one-time $6.3 million gain related to a real estate
transaction. In fiscal 2002, the decrease in other income, net primarily relates
to the one-time gains in the prior year discussed above, a $6.4 million loss on
a marketable security and $4.6 million of impairment charges related to other
equity investments. These decreases were partially offset by lower interest
expense as a result of our payment of all short-term borrowings in the first
quarter of fiscal 2002. In fiscal 2003, the decrease in other income, net
primarily relates to increased write-downs of marketable securities as a result
of fair value declines determined to be other than temporary totaling $13.4
million. Fiscal 2003 other income, net also included $4.5 million of impairment
charges related to other equity investments.

INCOME TAXES

We recorded income tax expense of $18.0 million in fiscal 2001, an income
tax benefit of $46.4 million in fiscal 2002, and income tax expense of $21.3
million in fiscal 2003. Our effective tax rates were 30%, 20%, and 31% for
fiscal 2001, 2002 and 2003, respectively. The reduced effective tax rate in
fiscal 2002 is a result of the impact of non-deductible amortization expense in
a year with a net pre-tax loss. For an analysis of the differences between the
statutory and effective income tax rates, see Note 6 to the accompanying
Consolidated Financial Statements.

As previously disclosed in our Quarterly Report on Form 10-Q for the
quarter ended December 31, 2002, we received a Revenue Agent's Report ("RAR")
from the Internal Revenue Service (IRS) for the tax 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 RAR 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. The case has been transferred to the IRS
Appeals division, and we are working with the IRS Appeals division to resolve
the issues. 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.

Recording income tax benefits results in the recognition of tax assets
representing current tax refunds receivable from net operating loss carrybacks
and/or the future benefit of utilizing net operating loss carryforwards and tax
credit carryforwards to reduce future tax obligations. We evaluate the deferred
tax assets related to net operating loss carryforwards and tax credit
carryforwards at each balance sheet date to determine their realizability,
considering currently enacted tax laws. If we determine that the assets are not
fully realizable, a valuation allowance will be recorded to reduce the asset
balances to their realizable values through a charge to income tax expense.
Determining whether we will be able to utilize the net operating loss
carryforwards and tax credit carryforwards requires that we estimate future
taxable income and make judgments regarding the timing of future tax
obligations. Actual taxable income could differ from our estimates. As of March
31, 2003, we believe it is more likely than not that we will be able to realize
the tax asset related to net operating loss carryforwards and therefore no
valuation allowance is recorded related to this asset. If we conclude that this
tax asset requires a valuation allowance in the future, the effect on income tax
expense could be material. As of March 31, 2003, we believe that it is more
likely than not that a portion of the deferred tax asset related to tax credit
carryforwards will not be realized and therefore we have recorded a valuation
allowance for this amount. If we conclude that this tax asset requires an
additional valuation allowance in the future, the effect on income tax expense
could be material. See Note 6 to the accompanying Consolidated Financial
Statements.

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RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In December 2002, the Financial Accounting Standards Board (FASB) issued
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure - An Amendment of FASB Statement No. 123." This Statement provides
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation and requires
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. We have elected not to adopt the recognition
and measurement provisions of SFAS No. 123 and continue to account for our
stock-based employee compensation plans under Accounting Principles Board (APB)
Opinion No. 25 and related interpretations and therefore the transition
provisions will not have an impact on our consolidated financial position or
results of operations. We have provided the required expanded disclosures in
Note 1(k) to the accompanying Consolidated Financial Statements.

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities under SFAS No. 133. This Statement is effective for contracts
entered into or modified after June 30, 2003, except for the provisions that
relate to SFAS No. 133 Implementation Issues that have been effective for
quarters that began prior to June 15, 2003 and for hedging relationships
designated after June 30, 2003. We believe that adoption of SFAS No. 149 will
not have a material effect on our consolidated financial position or results of
operations.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." This
Statement requires an issuer to classify specified financial instruments with
characteristics of both liabilities and equity as liabilities that were
previously classified either entirely as equity or between the liabilities
section and the equity section of the statement of financial position. This
Statement is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. We believe that adoption of SFAS No. 150
will not have a material effect on our consolidated financial position or
results of operations.

In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires certain
guarantees to be recorded at fair value and requires a guarantor to make
disclosures, even when the likelihood of making any payments under the guarantee
is remote. The initial recognition and initial measurement provisions are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002, and the disclosure requirements are effective for financial
statements of interim or annual periods ending after December 15, 2002. We
believe that adoption of FIN 45 will not have a material effect on our
consolidated financial position or results of operations. We have provided the
required disclosures in Note 9 to the accompanying Consolidated Financial
Statements.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an interpretation of Accounting Research Bulletin
No. 51" (FIN 46). FIN 46 requires the consolidation of entities in which an
enterprise absorbs a majority of the entity's expected losses, receives a
majority of the entity's expected residual returns, or both, as a result of
ownership, contractual or ot