1
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(MARK ONE)

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

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000

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

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 0-17136

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

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

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

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

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

As of August 9, 2000, there were outstanding 246,819,288 shares of Common
Stock, par value $.01, of the registrant.

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BMC SOFTWARE, INC. AND SUBSIDIARIES
QUARTER ENDED JUNE 30, 2000

INDEX

PAGE
----

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Balance Sheets as of March 31, 2000 and
June 30, 2000 (Unaudited)............................................... 3
Condensed Consolidated Statements of Earnings and Comprehensive
Income for the three months ended June 30, 1999 and 2000 (Unaudited).... 4
Condensed Consolidated Statements of Cash Flows for the three
months ended June 30, 1999 and 2000 (Unaudited)......................... 5
Notes to Condensed Consolidated Financial Statements (Unaudited).......... 6

Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition....................................................... 10

Item 3. Quantitative and Qualitative Disclosures about Market Risk................... 21

PART II. OTHER INFORMATION

Item 1. Legal Proceedings............................................................ 22

Item 6. Exhibits and Reports on Form 8-K............................................. 23

Signatures................................................................... 24

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3

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

BMC SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)

MARCH 31, JUNE 30,
2000 2000
---------- ----------
(UNAUDITED)

ASSETS
Current assets:
Cash and cash equivalents .......................................... $ 152.4 $ 139.7
Investment securities .............................................. 102.8 112.7
Trade accounts receivable, net ..................................... 374.1 243.4
Trade finance receivables, current ................................. 158.1 170.8
Other current assets ............................................... 108.8 95.1
---------- ----------
Total current assets ........................................ 896.2 761.7
Property and equipment, net .......................................... 337.5 371.0
Software development costs and related assets, net ................... 193.4 200.6
Investment securities ................................................ 820.3 890.6
Long-term finance receivables ........................................ 222.6 181.2
Acquired technology, net ............................................. 109.7 103.3
Goodwill and other intangibles, net .................................. 329.1 356.2
Other long-term assets ............................................... 53.3 61.4
---------- ----------
$ 2,962.1 $ 2,926.0
========== ==========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable ............................................. $ 29.3 $ 32.9
Accrued liabilities and other ...................................... 185.0 136.5
Short-term borrowings .............................................. 263.0 160.0
Current portion of deferred revenue ................................ 406.6 427.4
---------- ----------
Total current liabilities ................................... 883.9 756.8
Deferred revenue and other ........................................... 297.3 330.0
---------- ----------
Total liabilities ........................................... 1,181.2 1,086.8
Commitments and contingencies
Stockholders' equity:
Preferred stock .................................................... -- --
Common stock ....................................................... 2.4 2.5
Additional paid-in capital ......................................... 401.1 502.9
Retained earnings .................................................. 1,385.6 1,395.6
Accumulated other comprehensive income (loss) ...................... (3.4) (12.9)
---------- ----------
1,785.7 1,888.1
Less treasury stock, at cost ....................................... -- (8.4)
Less unearned portion of restricted stock compensation ............. (4.8) (40.5)
---------- ----------
Total stockholders' equity .................................. 1,780.9 1,839.2
---------- ----------
$ 2,962.1 $ 2,926.0
========== ==========

See the accompanying notes to condensed consolidated
financial statements.

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BMC SOFTWARE, INC. AND SUBSIDIARIES

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

THREE MONTHS ENDED
JUNE 30,
------------------------
1999 2000
--------- ---------

Revenues:
License ........................................................... $ 279.8 $ 229.7
Maintenance ....................................................... 112.0 125.7
Professional services ............................................. 8.9 17.3
--------- ---------
Total revenues ............................................ 400.7 372.7
--------- ---------
Selling and marketing expenses .................................... 127.0 152.2
Research and development expenses ................................. 57.5 57.5
Cost of maintenance services and product licenses ................. 37.2 49.1
Cost of professional services ..................................... 13.4 20.6
General and administrative expenses ............................... 34.3 38.3
Acquired research and development ................................. 80.8 11.7
Amortization of goodwill, acquired technology and intangibles ..... 30.3 39.6
Merger-related costs and compensation charges ..................... 12.5 2.1
--------- ---------
Total operating expenses .................................. 393.0 371.1
--------- ---------
Operating income .......................................... 7.7 1.6
Interest expense .................................................... (6.1) (2.1)
Interest and other income, net ...................................... 17.0 14.5
--------- ---------
Other income, net ......................................... 10.9 12.4
--------- ---------
Earnings before income taxes .............................. 18.6 14.0
Income taxes ........................................................ 2.2 4.0
--------- ---------
Net earnings .............................................. $ 16.4 $ 10.0
========= =========
Basic earnings per share ............................................ $ 0.07 $ 0.04
========= =========
Diluted earnings per share .......................................... $ 0.07 $ 0.04
========= =========
Shares used in computing basic earnings per share ................... 237.6 245.5
========= =========
Shares used in computing diluted earnings per share ................. 249.8 254.4
========= =========
Comprehensive Income:
Net earnings ...................................................... $ 16.4 $ 10.0
Foreign currency translation adjustment, net of taxes of
$0.7 and $-- ................................................... (2.1) (5.6)
Unrealized gain (loss) on securities available for sale:
Unrealized gain (loss), net of taxes of $2.5 and ($0.5) ........ 7.0 (1.0)
Realized (gain) included in net earnings, net of taxes of
$0.2 and $-- ................................................ (0.6) --
--------- ---------
Net unrealized gain (loss) on securities available for sale 6.4 (1.0)
Unrealized gain on derivative instruments:
Unrealized gain, net of taxes of $0.7 and $-- .................. 2.0 0.1
Realized (gain) included in net earnings, net of taxes of
$-- and $1.6 ................................................ -- (3.0)
--------- ---------
Net unrealized gain on derivative instruments ............. 2.0 (2.9)
--------- ---------
Comprehensive income ...................................... $ 22.7 $ 0.5
========= =========

See the accompanying notes to condensed consolidated
financial statements.

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BMC SOFTWARE, INC. AND SUBSIDIARIES

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

THREE MONTHS ENDED
JUNE 30,
--------------------
1999 2000
------ ------

Cash flows from operating activities:
Net earnings .................................................. $ 16.4 $ 10.0
Adjustments to reconcile net earnings to net cash provided
by operating activities:
Acquired research and development and merger-related
costs and compensation charges ........................... 81.9 13.8
Depreciation and amortization .............................. 44.4 64.1
Earned portion of restricted stock compensation ............ 0.7 2.0
Net change in receivables, payables, deferred revenue and
other components of working capital ....................... (96.7) 138.7
------ ------
Net cash provided by operating activities ............. 46.7 228.6
------ ------
Cash flows from investing activities:
Cash paid for technology acquisitions and other investments,
net of cash acquired ........................................ (635.5) (17.3)
Purchases of property and equipment ........................... (21.3) (47.0)
Capitalization of software development costs and related assets (16.8) (19.0)
Purchases of investment securities ............................ (21.2) (111.7)
Maturities of investment securities ........................... 45.4 30.5
Decrease in long-term finance receivables ..................... 74.3 41.4
------ ------
Net cash used in investing activities ................. (575.1) (123.1)
------ ------
Cash flows from financing activities:
Proceeds from borrowings ...................................... 498.8 --
Payments on borrowings ........................................ (15.0) (103.0)
Stock options exercised and other ............................. 12.7 10.5
Treasury stock acquired ....................................... -- (20.1)
------ ------
Net cash provided by (used in) financing activities ... 496.5 (112.6)
------ ------
Effect of exchange rate changes on cash ......................... (2.9) (5.6)
------ ------
Net change in cash and cash equivalents ......................... (34.8) (12.7)
Cash and cash equivalents, beginning of period .................. 347.9 152.4
------ ------
Cash and cash equivalents, end of period ........................ $313.1 $139.7
====== ======
Supplemental disclosure of cash flow information:
Cash paid for interest, net of amounts capitalized ............ $ 2.3 $ 1.5
Cash paid for income taxes .................................... $ 24.7 $ 9.6
Common stock and options issued and liabilities assumed
in acquisitions ............................................ $ -- $ 55.3

See the accompanying notes to condensed consolidated
financial statements.

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BMC SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(1) BASIS OF PRESENTATION

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

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

These financial statements should be read in conjunction with the Company's
audited financial statements for the year ended March 31, 2000, as filed with
the Securities and Exchange Commission on Form 10-K.

The Company acquired New Dimension Software, Ltd. (New Dimension) effective
April 14, 1999, and Evity, Inc. (Evity) effective April 25, 2000, in purchase
transactions. As such, their results have been included in the Company's fiscal
2000 and 2001 financial results from their respective acquisition dates.

(2) EARNINGS PER SHARE

Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per
Share" requires dual presentation of basic and diluted earnings per share (EPS).
Basic EPS is computed by dividing net income by the weighted average number of
common shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock. For purposes of this calculation,
outstanding stock options and unearned restricted stock are considered potential
common shares using the treasury stock method. For the three months ended June
30, 1999 and 2000, options to purchase 4.6 million and 12.1 million shares,
respectively, have been excluded from the calculation of EPS as they are
anti-dilutive. The following table summarizes the basic and diluted EPS
computations for the three months ended June 30, 1999 and 2000:

THREE MONTHS ENDED
JUNE 30,
------------------
1999 2000
----- -----
(IN MILLIONS,
EXCEPT PER SHARE DATA)

Basic earnings per share:
Net earnings......................................... $16.4 $10.0
----- -----
Weighted average number of common shares............. 237.6 245.5
----- -----
Basic earnings per share............................. $0.07 $0.04
===== =====
Diluted earnings per share:
Net earnings......................................... $16.4 $10.0
----- -----
Weighted average number of common shares............. 237.6 245.5
Incremental shares from assumed conversions of stock
options and other................................. 12.2 8.9
----- -----
Adjusted weighted average number of common shares.... 249.8 254.4
----- -----
Diluted earnings per share........................... $0.07 $0.04
===== =====

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(3) TECHNOLOGY ACQUISITIONS

The amount allocated to purchased IPR&D was charged to expense in the
quarter ended June 30, 2000, and represents the present value of the estimated
after-tax cash flows expected to be generated by the purchased technology, which
at the acquisition date, had not yet reached technological feasibility. The cash
flow estimates for revenues, for both completed and in-process technologies,
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 the Company and its competitors. Estimated operating expenses
and income taxes were deducted from estimated revenue projections to arrive at
estimated after-tax cash flows. Estimated operating expenses included cost of
goods sold, selling and marketing expenses, general and administrative expenses,
and research and development, including estimated costs to maintain the products
once they have been introduced into the market and are generating revenue. The
rates utilized to discount the estimated cash flows were 30% for in-process
technologies and 20% for developed technologies and were based primarily on
estimated cost of capital calculations.

The following unaudited pro forma consolidated results of operations for the
three months ended June 30, 1999 and 2000, are as if the acquisition of Evity
had occurred at the beginning of each period presented. The pro forma
consolidated results do not purport to be indicative of results that would have
occurred had the acquisition been in effect for the periods presented, nor do
they purport to be indicative of the results that will be obtained in the
future. The pro forma net earnings exclude the effect of the $7.0 million
write-off of IPR&D associated with the acquisition, in accordance with generally
accepted accounting principles.

THREE MONTHS ENDED
JUNE 30,
---------------------
1999 2000
-------- --------
(IN MILLIONS, EXCEPT
PER SHARE DATA)

Revenues............................... $ 400.7 $ 372.7
Net earnings........................... $ 8.2 $ 14.2
Basic EPS.............................. $ 0.03 $ 0.06
Diluted EPS............................ $ 0.03 $ 0.06

In connection with the Evity acquisition, 0.6 million restricted shares of
common stock were issued to certain employee shareholders of Evity. These shares
vest monthly over a two-year period based on continued employment with the
Company. The $25.1 million fair value of these shares was recorded as unearned
restricted stock compensation within stockholders' equity at the acquisition
date, and is being charged to expense as merger-related costs and compensation
charges over the service period.

During fiscal 1999, the Company entered into a technology agreement with
Envive Corporation and allocated $6.4 million of the committed transaction costs
to software assets, prepaid royalties and interest. During the first quarter of
fiscal 2001, this agreement was terminated and the remaining assets, totaling
$4.7 million, were charged to expense. This expense is included as an acquired
research and development charge in the accompanying statement of earnings and
comprehensive income for the three months ended June 30, 2000.

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(4) SEGMENT REPORTING

The Company operates primarily in one segment, distributing its enterprise
systems management software products. The Company also provides consulting and
education services related to these software products. During the first quarter
of fiscal 2001, management began reviewing the results and assessing the
performance of the professional services operations as a separate segment within
the Company. The following table reflects the results of the software and
professional services segments for the three months ended June 30, 1999 and
2000. Performance is measured based on operating margins, which reflect only the
direct controllable expenses of the segment and do not include allocation of
general and administrative expenses, amortization of goodwill, acquired
technology and intangibles, one-time charges, other income, net, and income
taxes. Total assets of the professional services segment are not significant.

THREE MONTHS ENDED
JUNE 30,
--------------------
1999 2000
-------- --------
(IN MILLIONS)

Software:
License and maintenance revenues.................... $ 391.8 $ 355.4
Operating expenses.................................. 221.7 258.8
-------- --------
Operating margin............................ 170.1 96.6
-------- --------
Professional services:
Revenues............................................ 8.9 17.3
Operating expenses.................................. 13.4 20.6
-------- --------
Operating loss.............................. (4.5) (3.3)
-------- --------
General and administrative expenses................... 34.3 38.3
Acquired research and development..................... 80.8 11.7
Amortization of goodwill, acquired technology and
intangibles........................................... 30.3 39.6
Merger-related costs and compensation charges......... 12.5 2.1
Other income, net..................................... 10.9 12.4
-------- --------
Consolidated earnings before income taxes............. $ 18.6 $ 14.0
======== ========

Revenues are tracked by both geography and product categories based upon the
predominant operating environments of enterprise computing: mainframe and
distributed systems. The Company is not organized into business units along
these product categories nor does it capture expenses on this basis. Revenues
relating to product categories are as follows:

THREE MONTHS ENDED
JUNE 30,
--------------------
1999 2000
-------- --------
(IN MILLIONS)

REVENUES
Mainframe:
License........................................... $ 190.9 $ 143.4
Maintenance....................................... 86.3 88.8
-------- --------
Total mainframe revenues.................. 277.2 232.2
Distributed systems:
License........................................... 88.9 86.3
Maintenance....................................... 25.7 36.9
-------- --------
Total distributed systems revenues........ 114.6 123.2
-------- --------
Total license and maintenance revenues.... $ 391.8 $ 355.4
======== ========

Mainframe revenues relate to products which operate primarily within the IBM
OS/390 mainframe operating system environment. Distributed systems revenues
relate to all non-mainframe products, which operate primarily within the Unix,
MS Windows 2000 and other distributed systems environments. Also classified as
distributed systems products are cross-platform products that operate in both
environments.

The table below summarizes revenues by geographic region.

THREE MONTHS ENDED
JUNE 30,
1999 2000
-------- --------
(IN MILLIONS)

REVENUES
North America..................................... $ 276.8 $ 245.4
Europe, Middle East and Africa.................... 98.7 97.5
Asia Pacific and Other............................ 25.2 29.8
-------- --------
Total revenues............................ $ 400.7 $ 372.7
======== ========

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(5) MERGER-RELATED COSTS

During the quarter ended June 30, 2000, the Company paid $0.5 million of
facility and termination costs under its plan of restructuring initiated in
March 1999 in connection with the merger with Boole & Babbage, Inc. (Boole). An
accrual of $6.1 million remains at June 30, 2000, for such payments to be made
in future periods.

(6) SUBSEQUENT EVENTS

In May 2000, the Company entered a definitive merger agreement to acquire
all of the ordinary shares of OptiSystems Solutions, Ltd. for cash of $10 per
share. This transaction closed on August 4, 2000, for total consideration of
approximately $70 million, including amounts paid for outstanding stock options
and warrants.

On August 9, 2000, the Company granted 9.7 million common stock options to
employees. The exercise price of these options was equal to the fair market
value of the Company's common stock on that date.

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

This section of the Form 10-Q contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, which are
identified by the use of the words "believe," "expect," "anticipate," "will,"
"contemplate," "would" and similar expressions that contemplate future events.
Numerous important factors, risks and uncertainties affect our operating
results, including, without limitation, those contained in this report, and
could cause our actual results to differ materially from the results implied by
these or any other forward-looking statements made by us or on our behalf. There
can be no assurance that future results will meet expectations. You should pay
particular attention to the important risk factors and cautionary statements
described in the section of this Report entitled "Certain Risks and
Uncertainties That Could Affect Future Operating Results." It is important that
the historical discussion below be read together with the attached condensed
consolidated financial statements and notes thereto, with the discussion of such
risks and uncertainties and with the audited financial statements and notes
thereto, and Management's Discussion and Analysis of Results of Operations and
Financial Condition contained in our Form 10-K for fiscal 2000.

A. RESULTS OF OPERATIONS AND FINANCIAL CONDITION

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

PERCENTAGE OF
TOTAL REVENUES
THREE MONTHS ENDED
JUNE 30,
----------------
1999 2000
----- -----

Revenues:
License.............................................. 69.8% 61.6%
Maintenance.......................................... 28.0 33.7
Professional services................................ 2.2 4.7
----- -----
Total revenues................................... 100.0 100.0
Selling and marketing expenses......................... 31.7 40.8
Research and development expenses...................... 14.3 15.4
Cost of maintenance services and product licenses...... 9.3 13.3
Cost of professional services.......................... 3.4 5.5
General and administrative expenses.................... 8.6 10.3
Acquired research and development...................... 20.2 3.1
Amortization of goodwill, acquired technology and
intangibles............................................ 7.5 10.6
Merger-related costs and compensation charges.......... 3.1 0.6
----- -----
Operating income.................................. 1.9 0.4
Interest expense....................................... (1.5) (0.6)
Interest and other income, net......................... 4.3 3.9
----- -----
Other income, net................................. 2.8 3.3
Earnings before income taxes...................... 4.7 3.7
Income taxes........................................... 0.6 1.0
----- -----
Net earnings...................................... 4.1% 2.7%
===== =====

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REVENUES

THREE MONTHS ENDED
JUNE 30,
--------------------
1999 2000 CHANGE
-------- --------- -------
(IN MILLIONS)

License:
North America.................. $ 202.4 $ 156.6 (22.6)%
International.................. 77.4 73.1 (5.6)%
-------- --------
Total license revenues... 279.8 229.7 (17.9)%
Maintenance:
North America.................. 68.5 78.7 14.9%
International.................. 43.5 47.0 8.0%
-------- --------
Total maintenance revenues 112.0 125.7 12.2%
Professional Services:
North America.................. 5.9 10.1 71.2%
International.................. 3.0 7.2 140.0%
-------- --------
Total professional services 8.9 17.3 94.4%
-------- --------
Total revenues........... $ 400.7 $ 372.7 (7.0)%
======== ========

Product Line Revenues

At June 30, 2000, we marketed over 450 software products designed to improve
the availability, performance and recoverability of enterprise applications,
databases and other information technology ("IT") systems components operating
in mainframe, distributed computing and Internet environments. Our mainframe
products accounted for 69% and 62% of total revenues in the quarters ended June
30, 1999 and 2000, respectively. Total revenues from mainframe products for the
three-months ended June 30, 2000 declined 16% as compared to the comparable
prior year period. In general, the revenues from these products are driven
largely by the growth in customers' processing capacity. The decline in the
first quarter of fiscal 2001 resulted primarily from a decrease in enterprise
license transactions during that period and a reduction in license upgrade fees
as discussed below. Unforeseen demand weakness was experienced across the board
in the June quarter by independent software vendors with mainframe product
portfolios. We believe that this indicates that external market factors
contributed significantly to this weakness. While it is impossible to assign
weights to any individual factor, market factors that may have contributed to
this weakness and the resultant negative effect on license revenues experienced
by us and our competitors included uncertainties associated with the future
roll-out of IBM's G7 mainframe product family and continued customer absorption
of MIPS capacity purchased in association with Year 2000 compliance programs.
We believe that various internal factors may have also contributed to the
decrease in enterprise license transactions, including unforeseen transitional
challenges experienced by our sales force associated with territory
re-assignments and new account teams for the new fiscal year.

The high performance utilities and administrative tools for IBM's IMS and
DB2 database management systems comprise the largest portion of our
mainframe-based revenues and total revenues. Our tools and utilities for IMS and
DB2 databases collectively contributed 45% and 39% of total revenues for the
three months ended June 30, 1999 and 2000, respectively, and 47% and 41% of
license revenues for the same periods. Total revenues and license revenues from
these product lines combined decreased 19% and 28%, respectively, in the first
quarter of fiscal 2001 compared to the comparable prior year period. The balance
of our mainframe products contributed 24% and 23% of total revenues and 21% of
license revenues for the three months ended June 30, 1999 and 2000,
respectively. Total revenues and license revenues for these other mainframe
products declined 12% and 19%, respectively, in the first quarter of fiscal
2001.

For the first quarter of fiscal 2001, our principal distributed systems
management product lines were the PATROL application and data management suite,
the PATROL for Performance Management products, the PATROL for Prediction and
Capacity Management products, the PATROL Enterprise Manager products, the
INCONTROL Control-M job scheduling, Control-D output management and Control-SA
security administration products, the PATROL DB database administration
products, and a management suite for IBM's MQSeries middleware technology. Late
in the first quarter of fiscal 2001, we introduced PATROL 2000, the first major
integration of the PATROL, BEST/1 and COMMAND/POST products into a comprehensive
solution for distributed systems. In total, the distributed systems product
lines contributed 29% and 33% of total revenues for the quarters ended June 30,
1999 and 2000, respectively, and 32% and 38% of license revenues for the same
periods. Total distributed systems revenues grew 8% and license revenues from
distributed systems declined 3% in the first quarter of fiscal 2001. In addition
to the various external and internal factors that we believe may have affected
our mainframe license revenues, our distributed systems license revenues may
have been negatively affected because many of our mainframe customers are also
customers of our distributed systems products and sometimes purchase distributed
systems products together with mainframe products in enterprise solutions. The
revenues from our distributed systems product offerings also depend upon the
continued market acceptance of our existing products and our ability to
successfully develop and deliver additional products for the distributed systems
environment. Despite the license revenue decrease in the first quarter of fiscal
2001, overall we have experienced rapid growth in our distributed systems
product lines since their introduction in late fiscal 1994. The distributed
systems market is highly competitive and dynamic and there can be no assurance
that this growth will resume.

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Product License Revenues

Our product license revenues consist of product license fees and license
upgrade fees. Product license fees are all fees associated with a customer's
licensing of a given software product for the first time. License upgrade fees
are all fees associated with a customer's purchase of the right to run a
previously licensed product on a larger computer or additional computers.
License upgrade fees are primarily generated by our mainframe products and
include fees associated with both current and future additional processing
capacity.

Our North American operations generated 72% and 68% of license revenues in
the three months ended June 30, 1999 and 2000, respectively. Decreased mainframe
license revenues were the largest contributor to the 23% decline in North
American license revenues in the first quarter of fiscal 2001, primarily related
to a decrease in capacity-based license upgrade fees. International license
revenues represented 28% and 32% of total license revenues for the quarters
ended June 30, 1999 and 2000, respectively. International license revenue
declined 6% from the first quarter of fiscal 2000 principally due to decreased
license upgrade fees associated with mainframe products, which offset a 16%
increase in product license fees generated from initial licenses.

The sustainability and growth of our mainframe-based license revenues are
dependent upon capacity-based license upgrade fees, particularly within our
largest customer accounts. During the quarters ended June 30, 1999 and 2000,
mainframe license upgrade fees (for current and future processing capacity)
accounted for 34% and 25% of our total revenues. Most of our largest mainframe
customers have entered into enterprise license agreements allowing them to
install our products on any number of CPUs, subject to a maximum limit on the
aggregate processing power of the CPUs as measured in millions of instructions
per second (MIPS). Additional license upgrade fees are due if the MIPS limit is
exceeded. Substantially all of these transactions include license upgrade fees
associated with additional processing capacity beyond the customers' current
usage levels, and some include product license fees for additional products. In
our typical enterprise license transactions, the fees associated with future
additional mainframe processing capacity comprise from one-half to substantially
all of the license fees received in these transactions. Prior to fiscal 2000, we
experienced several years of increasing demand from our mainframe customers for
the right to run our products on increased future mainframe processing capacity.
This led to larger single transactions with higher per MIPS discounts. Growth in
mainframe capacity-based license upgrade fees slowed in fiscal 2000 and such
fees actually declined in the first quarter of fiscal 2001. Because we expect
that we will continue to be dependent upon these capacity-related license
upgrade fees, continued slowing of this demand would adversely impact our
mainframe license revenues and operating results. See the discussion below under
the heading "Certain Risks and Uncertainties that Could Affect Future Operating
Results."

Maintenance and Support Revenues

Maintenance and support revenues represent the ratable recognition of fees
to enroll licensed products in our software maintenance, enhancement and support
program. Maintenance and support enrollment entitles customers to product
enhancements, technical support services and ongoing compatibility with
third-party operating systems, database management systems and applications.
These fees are generally charged annually and equal 15% to 20% of the discounted
price of the product. In addition, customers are entitled to reduced maintenance
percentages for prepayment of annual maintenance fees. Maintenance revenues also
include the ratable recognition of the bundled fees for any initial maintenance
services covered by the related perpetual license agreement.

Maintenance revenues have increased for the three months ended June 30, 2000
over the comparable prior year period as a result of the continuing growth in
the base of installed products and the processing capacity on which they run.
Maintenance fees increase in proportion to the aggregate processing capacity on
which the products are installed; consequently, we receive higher absolute
maintenance fees as customers install our products on additional processing
capacity. Due to the increased discounting for higher levels of additional
processing capacity, the maintenance fees on a per MIPS basis are typically
reduced in enterprise license agreements for mainframe products. Historically,
we have enjoyed high maintenance renewal rates for our mainframe-based products.
Should customers migrate from their mainframe applications or find alternatives
to our products, increased cancellations could adversely impact the
sustainability and growth of our maintenance revenues. To date, we have been
successful in extending our traditional maintenance and support pricing model to
the distributed systems market.

Professional Services Revenues

Professional services revenues, representing fees from implementation,
integration and education services performed during the period, increased 94%
during the three months ended June 30, 2000, over the comparable prior year
period. Our professional services headcount has increased significantly over the
last twelve months to meet the increasing demand for our expanding service
offerings.

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OPERATING EXPENSES

THREE MONTHS ENDED
JUNE 30,
--------------------
1999 2000 CHANGE
--------- --------- -------
(IN MILLIONS)

Selling and marketing.............................. $ 127.0 $ 152.2 19.8%
Research and development........................... 57.5 57.5 0.0%
Cost of maintenance services and product licenses.. 37.2 49.1 32.0%
Cost of professional services...................... 13.4 20.6 53.7%
General and administrative......................... 34.3 38.3 11.7%
Acquired research and development.................. 80.8 11.7 (85.5)%
Amortization of goodwill, acquired technology and
intangibles........................................ 30.3 39.6 30.7%
Merger-related costs and compensation charges...... 12.5 2.1 (83.2)%
---------- --------
Total operating expenses................. $ 393.0 $ 371.1 (5.6)%
========== ========

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. Personnel costs were a contributor to the expense growth in
the three months ended June 30, 2000, due to increased headcount over the
comparable prior year quarter. This was somewhat offset by a decrease in sales
commissions as a result of the 18% decrease in license revenues. Selling and
marketing expenses also increased as a result of our global user conference held
during the quarter, which offset the expense reduction related to the major
re-branding during the first half of the prior year which did not recur in the
first quarter of fiscal 2001. In general, marketing costs have continued to
increase to meet the requirements of marketing a greater number of increasingly
complex distributed systems products and to support a growing indirect
distribution channel.

Research and Development

Research and development expenses mainly comprise personnel costs related to
software developers and development support personnel, including software
programmers, testing and quality assurance personnel and writers of technical
documentation such as product manuals and installation guides. These expenses
also include computer hardware/software costs and telecommunications expenses
necessary to maintain our data processing center. Research and development
expenses remained flat during the first quarter of fiscal 2001. An increase in
these expenses was the result of compensation costs associated with increased
headcount of both software developers and development support personnel, as well
as associated benefits and facilities costs. These increased costs were entirely
offset by amounts capitalized in accordance with Statement of Financial
Accounting Standards (SFAS) No. 86, "Accounting for the Costs of Computer
Software to Be Sold, Leased or Otherwise Marketed." We capitalize our software
development costs when the projects under development reach technological
feasibility as defined by SFAS No. 86, and amortize these costs over the
products' estimated useful lives as cost of maintenance services and product
licenses. During the first quarters of fiscal 2000 and 2001, we capitalized
approximately $16.8 million and $19.0 million, respectively, of internal
software development costs. The growth in capitalized costs is primarily due to
increases in distributed systems product development and platform compatibility
efforts.

Cost of Maintenance Services and Product Licenses

Cost of maintenance services and product licenses consists of amortization
of purchased and internally developed software, costs associated with the
maintenance, enhancement and support of our products and royalty fees.
Maintenance, enhancement and support costs are increasing as a percentage of
maintenance fees as our product revenue mix shifts to distributed systems, which
require a higher level of support. We amortized $5.8 million and $8.0 million in
the first quarters of fiscal 2000 and 2001, respectively, of capitalized
internal software development costs pursuant to SFAS No. 86, including $0.7
million in the first quarter of fiscal 2000 to accelerate the amortization of
certain software products. We accelerated the amortization of these software
products as they were not expected to generate sufficient future revenues which
would be required for us to realize the carrying value of the assets. Royalties
also increased over the prior year.

We expect our cost of maintenance services and product licenses will
continue to increase as we capitalize a higher level of software development
costs and as we build our distributed systems product support organization,
which is less cost-effective than our mainframe support organization because of
the complexity and variability of the environments in which the products
operate. The distributed systems products operate in a high number of operating
environments, including operating systems, database management systems and ERP
applications, and require greater ongoing platform support development activity
relative to our OS/390 mainframe products.

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14

Cost of Professional Services

Cost of professional services consists primarily of personnel costs
associated with implementation, integration and education services that we
perform for our customers, and the related infrastructure to support this
business. The increase in these costs in the three months ended June 30, 2000,
over the comparable prior year period, resulted from increased headcount to
support the 94% growth 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, product
distribution, facilities management and human resources. Other costs included in
general and administrative expenses are fees paid for legal and accounting
services, consulting projects, insurance and costs of managing our foreign
currency exposure. Growth in general and administrative expenses for the three
months ended June 30, 2000 over the same period in the prior year was primarily
attributable to increased personnel costs, legal fees and bad debt expense,
which offset reduced management bonuses for the quarter.

Acquired Research and Development

Acquired IPR&D costs for the three months ended June 30, 1999 and 2000, were
$80.8 million and $11.7 million, respectively. These technology charges
primarily relate to the acquisitions of New Dimension in the first quarter of
fiscal 2000 and Evity in the first quarter of fiscal 2001. The acquired IPR&D
charge for the three months ended June 30, 2000, also includes the write-off of
assets totaling $4.7 million, related to a technology agreement with Envive
Corporation that was terminated during the quarter.

The following table presents information concerning the purchase price
allocations for the acquisitions accounted for under the purchase method for the
three months ended June 30, 1999 and 2000. See the discussion of the New
Dimension acquisition in the fiscal 2000 Annual Report on Form 10-K.

ACQUIRED GOODWILL TOTAL
COMPANY NAME SOFTWARE IPR&D AND OTHER PRICE
--------------- -------- -------- --------- ---------
(IN MILLIONS)

Fiscal 2000:
New Dimension. $ 126.3 $ 80.8 $ 465.9 $ 673.0
======== ======= ======== =========

Fiscal 2001:
Evity......... $ 2.5 $ 7.0 $ 57.8 $ 67.3
======== ======= ======== =========

On April 25, 2000, the Company 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. 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 Web site 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 represent
next-generation technologies that are 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 spent nearly $1 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 the Company expects to begin benefiting from the
developed technologies.

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15

In making its purchase price allocation, management considered present value
calculations of income, an analysis of project accomplishments and remaining
outstanding items, an assessment of overall contributions, as well as project
risks. The value assigned to purchased in-process technology was 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. The revenue projection
used to value the in-process research and development was 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 the Company and its
competitors. The resulting net cash flows from such projects are based on
management's estimates of cost of sales, operating expenses, and income taxes
from such projects.

Aggregate revenues for the Evity products were estimated to grow at a
compounded annual growth rate of approximately 155% for the five years following
introduction, assuming the successful completion and market acceptance of the
major 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 estimated cost of capital calculations. Due to the nature of the
forecast and the risks associated with the projected growth and profitability of
the developmental projects, a discount rate of 30% was considered appropriate
for the in-process R&D. These discount rates were commensurate with Evity's
stage of development and the uncertainties in the economic estimates described
above.

If these projects are not successfully developed, the sales and
profitability of the combined company may be adversely affected in future
periods. Additionally, the value of other acquired intangible assets may become
impaired.

Amortization of Goodwill, Acquired Technology and Intangibles

In connection with the application of the purchase accounting method to
certain of our acquisitions, portions of the purchase prices were allocated to
goodwill, workforce, customer base, software and other intangible assets. We are
amortizing these intangibles over three to five-year periods, which reflect the
estimated useful lives of the respective assets. The increase in the quarterly
amortization expense results from amortizing the New Dimension assets for a full
quarter in fiscal 2001 versus a portion of the quarter in fiscal 2000, and
including the amortization of the Evity assets discussed above.

Merger-Related Costs and Compensation Charges

In conjunction with our merger with Boole in March 1999, management approved
a formal plan of restructuring (the "Plan") which included steps to be taken to
integrate the operations of the two companies, consolidate duplicate facilities
and streamline operations to achieve reductions in overhead expenses in future
periods. In connection with the Plan, we charged $12.5 million to expense during
the first quarter of fiscal 2000. No additional charges related to the Plan were
recorded during the first quarter of fiscal 2001 and as of June 30, 2000, we
have remaining accrued merger-related costs of approximately $6.1 million for
facility and termination costs to be paid in future periods. During the three
months ended June 30, 2000, we recorded compensation charges of $2.1 million
related to the vesting of common stock issued as part of the Evity acquisition
to certain Evity employee shareholders who we employed after the acquisition.

OTHER INCOME, NET

For the first quarter of fiscal 2001, other income, net was $12.4 million,
reflecting an increase of 14% from $10.9 million in the same quarter of fiscal
2000. Other income, net consists primarily of interest earned on cash, cash
equivalents and investment securities and interest expense on short-term
borrowings. The increase in other income, net is primarily due to the decrease
in interest expense as a result of reduced borrowings outstanding during the
first quarter of fiscal 2001.

INCOME TAXES

For the three months ended June 30, 2000, income tax expense was $4.0
million, compared to $2.2 million for the same period in fiscal 2000. Our
effective tax rate was 29% for the three months ended June 30, 2000 and 12% for
the comparable prior year period, and is below the federal statutory rate of 35%
due to lower income taxes associated with our European operations and the effect
of tax-exempt interest earned on investments. The lower tax expense and
effective rate in the first quarter of fiscal 2000 resulted primarily from the
tax benefit related to the New Dimension IPR&D charge and certain other one-time
charges associated with restructuring efforts.

15
16

LIQUIDITY AND CAPITAL RESOURCES

We continue to finance our growth primarily through funds generated from
operations. For the three months ended June 30, 2000, net cash provided by
operating activities was $228.6 million. As of June 30, 2000, we had cash, cash
equivalents and investment securities of $1.1 billion and short-term borrowings
of $160.0 million.

During the first quarter of fiscal 2001, our board of directors authorized
us to purchase up to $500 million in common stock. We repurchased 465,000 common
shares on the open market for $20.1 million during the first quarter of fiscal
2001.

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

B. CERTAIN RISKS AND UNCERTAINTIES THAT COULD AFFECT FUTURE OPERATING RESULTS

Our Stock Price is Volatile.

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

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

Our revenues and results of operations are difficult to predict and may
fluctuate substantially quarter to quarter. The timing and amount of our license
revenues are subject to a number of factors that make estimation of operating
results prior to the end of a quarter extremely uncertain. We generally operate
with little or no sales backlog and, as a result, license revenues in any
quarter are dependent upon contracts entered into or orders booked and shipped
in that quarter. Most of our sales are closed at the end of each quarter. Our
business remains dependent on closing large enterprise license transactions,
which can have sales cycles of up to a year or more and require approval by a
customer's upper management. These transactions are typically difficult to
manage and predict. Failure to close an expected individually significant
transaction or multiple expected transactions could cause our revenues and
earnings in a period to fall short of expectations. We generally do not know
whether revenues and earnings will meet expectations until the final days or day
of a quarter.

We have a High Degree of Operating Leverage.

Our business model is characterized by a very high degree of operating
leverage. A substantial portion of our operating costs and expenses consists of
employee and facility related costs, which are relatively fixed over the short
term. In addition, our expense levels and hiring plans are based substantially
on our projections of future revenues. If near term demand weakens in a given
quarter, there would likely be a material adverse effect on operating results
and a resultant drop in our stock price.

Our Operating Margins May Decline Further.

There is a risk that our historically high operating margins may not be
sustainable and may continue to decline, which would adversely affect our
earnings. Our operating margins, excluding amortization of goodwill, acquired
technology and intangibles and one-time charges, declined during fiscal 2000 and
declined further during the first quarter of fiscal 2001 as compared to fiscal
1999 and prior periods. We do not compile margin analysis other than on an
aggregated basis; however, we are aware that operating expenses as a percentage
of revenues associated with our distributed systems products are substantially
higher than those associated with our traditional mainframe products. Since our
mix of business continues to shift to distributed systems, operating margins
will experience more pressure. In addition, we are not currently profitable in
our growing professional services business. We may be unable to increase or even
maintain our current level of profitability on a quarterly or annual basis in
the future. Additionally, we have acquired businesses experiencing lower
operating margins than us.

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17

We May Not be Able to Attract and Retain Qualified Personnel.

Our future success depends on the continued service of our executive
officers and other key administrative, sales and marketing and support
personnel. There is currently a shortage of personnel possessing the technical
background necessary to sell, support and develop our products effectively.
Competition for skilled personnel is intense, and we may not be able to attract,
assimilate or retain highly qualified personnel in the future. Hiring qualified
sales, marketing, administrative, research and development and customer support
personnel is very competitive in our industry, particularly in some of the
markets where our development teams are located, such as San Jose, California,
Austin, Texas and Waltham, Massachusetts. In addition to our direct competitors,
we are competing for qualified personnel with start-ups and small companies,
many of which are offering significant ownership interests in the form of stock
options to attract employees. In competing with start-ups and other high growth
companies, our recent stock price performance, with our shares trading well
below the average stock price over the last two years, has made it more
difficult for us to attract and retain employees. Consequently, our growth rates
may be limited by our ability to attract qualified personnel.

Decreasing Demand for Mainframe Processing Capacity Could Adversely Affect
Revenues.

Fees from enterprise license transactions remain a fundamental component of
our revenues and the primary source of mainframe license revenues. These
revenues depend on our customers planning to grow their mainframe capacity and
continuing to perceive an increasing need to use our existing software products
on substantially greater mainframe processing capacity in future periods. Over
the past year, IBM has experienced a decline in shipments of new mainframe
hardware. In addition, the continued growth of distributed database management
systems may have an adverse effect on growth rates for mainframe computing
systems. Although we believe that businesses will continue to demand greater
mainframe computing capacity and that e-business will be a driver of this
demand, there can be no assurance as to whether future demand for mainframe
capacity will continue to grow or not. Slower growth in our customers' mainframe
processing capacity will adversely affect our revenues.

Increased Competition and Pricing Pressures Could Adversely Affect Our Sales.

The market for systems management software has been increasingly competitive
for the past number of years and is currently intensifying. We compete with a
variety of software vendors including IBM and Computer Associates International,
Inc. (CA). We derived approximately 64% of our total revenues in fiscal 2000 and
62% of our total revenues in the first quarter of fiscal 2001 from software
products for IBM and IBM-compatible mainframe computers. IBM continues to focus
on reducing the overall software costs associated with the OS/390 mainframe
platform. IBM continues, directly and through third parties, to aggressively
enhance its utilities for IMS and DB2 to provide lower cost alternatives to the
products provided by us and other independent software vendors. IBM has
significantly increased its level of activity in the IMS and DB2 high speed
utility markets over the last two years. 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 will be materially adversely affected. CA
entered the mainframe database tools and utilities market with its acquisition
of Platinum Technology International, Inc. (DB2 tools and utilities) and
Innovative Designs, Inc. (IMS tools and utilities) and is competing with us in
these markets.

Capacity-based upgrade fees associated with both current and future
processing capacity contributed approximately one-fourth to one-third of our
total revenues in each of fiscal years 1998, 1999 and 2000 and the first quarter
of fiscal 2001. The charging of upgrade fees based on the capacity to which the
product is licensed is standard among mainframe systems software vendors,
including IBM. While we believe our current pricing policies properly reflect
the value provided by our products, the pricing of mainframe systems software
and particularly the charging of capacity-based upgrade fees is under constant
pressure from customers and competitive vendors. IBM continues to reduce the
costs of its mainframe systems software to increase the overall cost
competitiveness of its mainframe hardware and software products, and generally
charges less for its software products. In connection with an upcoming hardware
release, IBM is discussing potential changes to its mainframe software pricing,
including a new usage-pricing model. These actions continue to increase pricing
pressures within the mainframe systems software markets. We have continued to
reduce the cost of our mainframe tools and utilities in response to these and
other competitive pressures.

17
18

Maintenance Revenue Growth Could Slow.

Maintenance revenues have increased over the last three fiscal years and the
first quarter of fiscal 2001 as a result of the continuing growth in the base of
installed products and the processing capacity on which they run. Maintenance
fees increase as the processing capacity on which the products are installed
increases; consequently, we receive higher absolute maintenance fees as
customers install our products on additional processing capacity. Due to
increased discounting for higher levels of additional processing capacity, the
maintenance fees on a per MIPS basis are typically reduced in enterprise license
agreements for our mainframe products. Historically, we have enjoyed high
maintenance renewal rates for our mainframe-based products. Should customers
migrate from their mainframe applications or find alternatives to our products,
increased cancellations could adversely impact the sustainability and growth of
our maintenance revenues. To date, we have been successful in extending our
traditional maintenance and support pricing model to the distributed systems
market. Renewal rates for maintenance on our distributed systems products are
lower than on our mainframe products.

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

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

Because the Market for E-Business Solutions is New and Evolving, We Cannot
Accurately Predict the Future Growth Rate of this Market or its Ultimate
Size.

We are increasingly focusing our selling and marketing efforts on
providing solutions for e-business applications. This is a new and evolving
market, and there can be no assurance that customers will perceive a need for or
accept our e-business solutions. In addition, our success in the e-business
market may ultimately depend on the success of the Internet as a medium for
conducting business transactions. As the Internet continues to experience
significant growth in the number of users and the complexity of Web-based
applications increases, the Internet infrastructure may not be able to support
the demands placed on it or the performance or reliability of the Internet might
be adversely affected. Failure of a significant market to develop for e-business
application solutions, failure of our e-business solutions to achieve broad
market acceptance, or reduced growth in the Internet as a medium for business
transactions could adversely affect our business, operating results and
financial condition.

Changes in Pricing Practices Could Adversely Affect Revenues and Earnings.

We may choose in fiscal 2001 or a future fiscal year to make changes to our
product packaging, pricing or licensing programs. If made, such changes may have
a material adverse impact on revenues or earnings.

Our Customers May Not Accept our Product Strategies.

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

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19

Risks Related to Business Combinations.

As part of our overall strategy, we have acquired or invested in, and plan
to continue to acquire or invest in, complementary companies, products, and
technologies and to enter into joint ventures and strategic alliances with other
companies. Our acquisitions of BGS Systems, Inc. (BGS) in March 1998, Boole in
March 1999, New Dimension in April 1999 and Evity in April 2000 are the results
of this strategy. Risks commonly encountered in such transactions include: the
difficulty of assimilating the operations and personnel of the combined
companies; the risk that we may not be able to integrate the acquired
technologies or products with our current products and technologies; the
potential disruption of our ongoing business; the inability to retain key
technical and managerial personnel; the inability of management to maximize our
financial and strategic position through the successful integration of acquired
businesses; and decreases in reported earnings as a result of charges for
in-process research and development and amortization of goodwill and acquired
intangible assets.

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

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

Risks Associated With Managing Growth.

We have experienced an extended period of: (i) significant revenue growth;
(ii) acquisitions; (iii) expansion of our software product lines and supported
platforms; (iv) significant expansion in our number of employees; (v) increased
pressure on the viability and scope of our operating and financial systems; and
(vi) expansion in the geographic scope of our operations. This growth has
resulted in new and increased responsibilities for management personnel and has
placed a significant strain upon our management, operating and financial
controls and resources, including our information systems and services and
development organizations. To accommodate recent growth, compete effectively and
manage potential future growth, we must continue to implement and improve the
speed and quality of our information decision support systems, management
decisions, reporting systems, procedures and controls. Our personnel,
procedures, systems and controls may not be adequate to support our future
operations. During fiscal 2000, we realigned our product development and
marketing operations along five product market oriented groups. It is uncertain
if this reorganization will yield the desired benefits and whether this
organizational structure will prove effective.

Enforcement of Our Intellectual Property Rights.

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

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20

Possibility of Infringement Claims.

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

Risk of Year 2000 Related Problems.

Through the seven months following January 1, 2000, we have not experienced
any material failures related to Year 2000; however, there remains a risk that
latent Year 2000 problems could affect us or our products. We have tested the
ability of our software products to process Year 2000 data without interruption
or errors and believe that our products are substantially Year 2000 compliant.
Despite these tests, there can be no assurance that undetected errors or defects
do not exist that could cause these software products to fail to process Year
2000 data correctly. There is a risk that such undetected errors or defects
could surface at a later date, and that customers may assert claims against us
for any losses resulting from such errors or defects. To date, we are not aware
of any material claims being asserted or made against us related to Year 2000
failures. However, we cannot predict whether or to what extent any legal claims
will be brought, or whether we will suffer any liability as a result of any
adverse consequences to our customers related to Year 2000 failures.

Risks Related to International Operations and the Euro Currency.

We have committed, and expect to continue to commit, substantial resources
and funding to build our international service and support infrastructure.
Operating costs in many countries, including many of those in which we operate,
are higher than in the United States. In order to increase international sales
in fiscal 2001 and subsequent periods, we must continue to globalize our
software product lines; expand existing and establish additional foreign
operations; hire additional personnel; identify suitable locations for sales,
marketing, customer service and development; and recruit international
distributors and resellers in selected territories. Future operating results are
dependent on sustained performance improvement by our international offices,
particularly our European operations. Revenue growth by our European operations
has been slower than revenue growth in North America. There can be no assurance
that we will be successful in accelerating the revenue growth of our European
operations. Our operations and financial results internationally could be
significantly adversely affected by several risks such as changes in foreign
currency exchange rates, sluggish regional economic conditions and difficulties
in staffing and managing international operations. Generally, our foreign sales
are denominated in our foreign subsidiaries' local currencies. If these foreign
currency exchange rates change unexpectedly, we could have significant gains or
losses. Many systems and applications software vendors are experiencing
difficulties internationally.

The European Union's adoption of the Euro single currency raises a variety
of issues associated with our European operations. Although the transition will
be phased in over several years, the Euro became Europe's single currency on
January 1, 1999. Our foreign exchange exposures to legacy sovereign currencies
of the participating countries in the Euro became foreign exchange exposures to
the Euro upon its introduction. Although we are not aware of any material
adverse financial risk consequences of the change from legacy sovereign
currencies to the Euro, conversion may result in problems, which may have an
adverse impact on our business since we may be required to incur unanticipated
expenses to remedy these problems.

Conditions in Israel.

Our INCONTROL and recently-acquired OptiSystems operations are conducted
partially in Israel and, accordingly, we are directly affected by economic,
political and military conditions in Israel. Any major hostilities involving
Israel or the interruption or curtailment of trade between Israel and its
present trading partners could materially adversely affect our business,
operating results and financial condition.

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Israel's economy has been subject to numerous destabilizing factors,
including a period of rampant inflation in the early to mid-1980's, low foreign
exchange reserves, fluctuations in world commodity prices, military conflicts
and civil unrest. Since the establishment of the State of Israel in 1948, a
state of hostility has existed, varying in degree and intensity, between Israel
and the Arab countries. In addition, Israel and companies doing business with
Israel have been the subject of an economic boycott by the Arab countries since
Israel's establishment. Although Israel has entered into various agreements with
certain Arab countries and the Palestinian Authority, and various declarations
have been signed in connection with efforts to resolve some of the economic and
political problems in the Middle East, we cannot predict whether or in what
manner these problems will be resolved.

In addition, certain of our Israeli employees are currently obligated to
perform annual reserve duty in the Israel Defense Forces and are subject to
being called for active military duty at any time. New Dimension and OptiSystems
operated effectively under these requirements since their inceptions. However,
we cannot predict the effect of these obligations on our Israeli operations in
the future.

Possible Adverse Impact Of Recent Accounting Pronouncements.

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to a variety of risks, including foreign currency exchange
rate fluctuations and changes in the market value of our investments. In the
normal course of business, we employ established policies and procedures to
manage these risks including the use of derivative instruments. There have been
no material changes in our foreign exchange risk management strategy or our
investment securities subsequent to March 31, 2000, therefore our foreign
currency exchange rate risk and interest rate risk related to investments remain
substantially unchanged from the description in our Form 10-K for the year ended
March 31, 2000.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

On March 9, 1999, a class action complaint was filed against us and
four of our senior executives alleging violations of Sections 10(b) and 20(a) of
the Securities Exchange Act in connection with our financial statement
presentation following our acquisition of BGS in March 1998 in a
pooling-of-interests transaction. Four similar actions were filed in the
Southern District of Texas. All of the actions were subsequently consolidated in
a single action. The lawsuits were filed following our announcement that we were
restating our historical financial results to include BGS's results in our
financial statements as a condition to the Securities and Exchange Commission
declaring effective our registration statement on Form S-4 relating to our
acquisition of Boole. We filed a motion to dismiss the complaint. On June 15,
2000, a United States Magistrate Judge issued an Opinion and Recommendation
recommending to the United States District Judge that our motion to dismiss be
granted and that the case be dismissed. On July 27, 2000, a Final Judgment was
entered by the United States District Judge adopting the Magistrate Judge's
Memorandum and Recommendation and ordering that the case be dismissed. Our
counsel has been informed that the Final Judgment will not be appealed.

On February 4, 2000, an action styled, Dov Klein v. BMC Software, Inc.,
Richard P. Gardner, Stephen B. Solcher, Roy J. Wilson, Kevin M. Weiss, Kevin M.
Klausmeyer, Max P. Watson, Jr., William M. Austin, Wayne S. Morris, M. Brinkley
Morse, Robert E. Beauchamp, and Theodore W. Van Duyn, No. 00-CV-359, was filed
in the United States District Court for the Southern District of Texas, Houston
Division. This is a purported class action filed on behalf of all purchasers of
our securities between July 29, 1999 and January 4, 2000. The plaintiff alleges
that BMC Software and eleven current and former senior executives violated
Sections 10(b) and 20(a) of the Securities Exchange Act and Rule 10b-5. The
plaintiff contends that BMC Software and the individual defendants artificially
inflated our stock price prior to the announcement of operating results for the
third quarter of fiscal 2000 by extending unusual payment terms to purchasers of
our products, failing to disclose softening demand and increasing competition
for our products, and failing to disclose difficulties in managing our sales
force. The plaintiff seeks unspecified compensatory damages, interest and costs,
including legal fees. The action is subject to the Private Securities Litigation
Reform Act of 1995 (PSLRA). On March 9, 2000, the court consolidated four
similar actions, ordered that all subsequently filed similar actions be
consolidated, and set out a briefing schedule. Under the briefing schedule, the
defendants are not required to move, plead, or otherwise respond until 60 days
after (1) the court appoints a lead plaintiff and lead counsel under the PSLRA
and (2) an amended complaint is filed by the plaintiffs. On April 3, 2000,
certain plaintiffs filed an application to be appointed lead plaintiff and lead
counsel under the PSLRA. That motion was granted on June 13, 2000. The
plaintiffs are required to file an amended complaint by August 14, 2000. We
intend to deny the allegations in the consolidated complaint and defend the
consolidated action vigorously. We anticipate that we will file a motion to
dismiss the case. At this early stage of the litigation, it is not possible to
estimate potential damages, but it appears that if liability were established,
an unfavorable judgment or settlement could have a material adverse effect on
our financial position or results of operations.

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

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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits.

The following Exhibits are filed with this report.

EXHIBIT
NUMBER DESCRIPTION
------- -----------

10.1 -- BMC Software, Inc. 2000 Employee Stock Incentive Plan.

10.2 -- Form of Executive Employment Agreement between BMC Software, Inc. and Max
Watson, William Austin, Robert Beauchamp and Darroll Buytenhuys.

27 -- Financial Data Schedule.

(b) Reports on Form 8-K.

None

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SIGNATURES

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

BMC SOFTWARE, INC.

By: /s/ MAX P. WATSON JR.
----------------------------
Max P. Watson Jr.
Chairman of the Board, President and
Chief Executive Officer

August 11, 2000

By: /s/ WILLIAM M. AUSTIN
---------------------------
William M. Austin
Senior Vice President and
Chief Financial Officer

August 11, 2000

By: /s/ JOHN W. COX
----------------------------
John W. Cox
Vice President, Controller and
Chief Accounting Officer

August 11, 2000

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INDEX TO EXHIBITS

EXHIBIT
NUMBER DESCRIPTION
------- -----------

10.1 -- BMC Software, Inc. 2000 Employee Stock Incentive Plan.

10.2 -- Form of Executive Employment Agreement between BMC Software, Inc. and Max
Watson, William Austin, Robert Beauchamp and Darroll Buytenhuys.

27 -- Financial Data Schedule.