1 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 December 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ----------------- ------------------ Commission file number 0-17136 BMC SOFTWARE, INC. (Exact name of registrant as specified in its charter) Delaware 74-2126120 (State or other jurisdiction of (IRS Employer incorporation or organization) identification No.) BMC Software, Inc. 2101 CityWest Boulevard Houston, Texas 77042 (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 February 5, 1998, there were outstanding 102,777,632 shares of Common Stock, par value $.01, of the registrant.
2 BMC SOFTWARE, INC. AND SUBSIDIARIES Quarter Ended December 31, 1997 INDEX <TABLE> <CAPTION> Page ---- <S> <C> PART I. FINANCIAL INFORMATION Item 1. Financial Statements 3 Condensed Consolidated Balance Sheets December 31, 1997 (Unaudited) and March 31, 1997 3 Condensed Consolidated Statements of Earnings Three months and Nine months ended December 31, 1997 and 1996 (Unaudited) 5 Condensed Consolidated Statements of Cash Flows Nine months ended December 31, 1997 and 1996 (Unaudited) 6 Notes to Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 9 PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders 20 Item 6. Exhibits and Reports on Form 8-K 20 SIGNATURES 21 </TABLE> 2
3 Part I. FINANCIAL INFORMATION Item 1. Financial Statements BMC SOFTWARE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) <TABLE> <CAPTION> December 31, March 31, ASSETS 1997 1997 ---- ---- (Unaudited) <S> <C> <C> Current assets: Cash and cash equivalents $ 85,478 $ 79,794 Investment securities 43,218 59,159 Receivables: Trade, net 126,660 87,576 Interest and other 13,448 11,247 -------- -------- Total receivables 140,108 98,823 Prepaid expenses and other 7,774 10,606 -------- -------- Total current assets 276,578 248,382 -------- -------- Property and equipment, net 143,909 116,296 Software development costs, net 57,776 39,486 Purchased software, net 34,577 19,735 Finance receivables 13,578 4,397 Investment securities 423,433 402,742 Deferred charges and other assets 6,153 13,121 -------- -------- $956,004 $844,159 ======== ======== </TABLE> See accompanying notes to condensed consolidated financial statements. 3
4 BMC SOFTWARE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) (continued) <TABLE> <CAPTION> December 31, March 31, LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1997 ---- ---- (Unaudited) <S> <C> <C> Current liabilities: Trade accounts payable $ 3,176 $ 9,439 Accrued liabilities and other 60,642 50,025 Current portion of deferred revenue 180,616 145,199 --------- --------- Total current liabilities 244,434 204,663 --------- --------- Deferred revenue and other 86,825 93,284 --------- --------- Total liabilities 331,259 297,947 --------- --------- Stockholders' equity: Common stock 1,050 1,050 Additional paid-in capital 95,872 82,391 Retained earnings 664,258 565,122 Foreign currency translation adjustment (1,483) (820) Unrealized gain (loss) on securities available for sale 1,082 (750) --------- --------- 760,779 646,993 Less treasury stock 132,121 96,901 Less unearned portion of restricted stock compensation 3,913 3,880 --------- --------- Total stockholders' equity 624,745 546,212 --------- --------- $ 956,004 $ 844,159 ========= ========= </TABLE> See accompanying notes to condensed consolidated financial statements. 4
5 BMC SOFTWARE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (in thousands, except per share data) (Unaudited) <TABLE> <CAPTION> Three Months Ended Nine Months Ended December 31, December 31, ------------ ------------ 1997 1996 1997 1996 ---- ---- ---- ---- <S> <C> <C> <C> <C> Revenues: Licenses $140,992 $103,989 $358,939 $268,644 Maintenance 55,010 46,071 158,186 133,966 -------- -------- -------- -------- Total revenues 196,002 150,060 517,125 402,610 -------- -------- -------- -------- Operating expenses: Selling and marketing 52,836 40,094 146,974 113,355 Research and development 27,152 20,056 71,202 57,748 Cost of maintenance services and product licenses 17,599 13,657 53,318 40,793 General and administrative 15,433 12,343 39,257 34,021 Acquired research and development costs -- -- 65,473 11,259 -------- -------- -------- -------- Total operating expenses 113,020 86,150 376,224 257,176 -------- -------- -------- -------- Operating income 82,982 63,910 140,901 145,434 Other income 8,246 5,300 21,542 14,233 -------- -------- -------- -------- Earnings before taxes 91,228 69,210 162,443 159,667 Income taxes 26,451 21,109 63,307 49,208 -------- -------- -------- -------- Net earnings $ 64,777 $ 48,101 $ 99,136 $110,459 ======== ======== ======== ======== Basic earnings per share $ .64 $ .48 $ .98 $ 1.10 ======== ======== ======== ======== Shares used in computing basic earnings per share 101,560 100,883 101,432 100,582 ======== ======== ======== ======== Diluted earnings per share $ .60 $ .45 $ .92 $ 1.03 ======== ======== ======== ======== Shares used in computing diluted earnings per share 108,043 107,748 108,155 106,921 ======== ======== ======== ======== </TABLE> See accompanying notes to condensed consolidated financial statements. 5
6 BMC SOFTWARE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (Unaudited) <TABLE> <CAPTION> Nine Months Ended December 31, ------------ 1997 1996 ---- ---- <S> <C> <C> Cash flows from operating activities: Net earnings $ 99,136 $ 110,459 Adjustments to reconcile net earnings to net cash provided by operating activities: Acquired research and development costs 65,473 11,259 Depreciation and amortization 43,481 23,904 Net change in receivables, payables and other items (13,161) 57,925 --------- --------- Total adjustments 95,793 93,088 --------- --------- Net cash provided by operating activities 194,929 203,547 --------- --------- Cash flows from investing activities: Technology acquisitions, net of cash acquired (72,044) (14,714) Purchased software and related assets (2,480) (6,825) Capital expenditures (49,436) (20,733) Capitalization of software development (27,621) (15,518) Purchases of investment securities (69,547) (184,704) Proceeds from investment securities 66,629 30,288 Increase in long-term finance receivables (9,181) (692) --------- --------- Net cash used in investing activities (163,680) (212,898) --------- --------- Cash flows from financing activities: Earned portion of restricted stock compensation 1,098 1,204 Income tax reduction relating to stock options 27,473 2,458 Stock options exercised and other 17,231 12,029 Treasury stock acquired (70,703) (880) --------- --------- Net cash (used in) provided by financing (24,901) 14,811 activities --------- --------- Effect of exchange rate changes on cash (664) (334) --------- --------- Net change in cash and cash equivalents 5,684 5,126 Cash and cash equivalents at beginning of period 79,794 62,128 --------- --------- Cash and cash equivalents at end of period $ 85,478 $ 67,254 ========= ========= Supplemental disclosure of cash flow information: Cash paid for Income taxes $ 37,022 $ 53,532 </TABLE> See accompanying notes to condensed consolidated financial statements. 6
7 BMC SOFTWARE, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements Note 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"). All significant intercompany balances and transactions have been eliminated in consolidation. The accompanying unaudited interim condensed consolidated financial statements reflect all adjustments (consisting of normal recurring accruals) which, in the opinion of management, are necessary for a fair presentation of the results for the interim 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 annual audited financial statements for the year ended March 31, 1997, as filed with the Securities and Exchange Commission on Form 10-K. Note 2 - Recently Issued Accounting Pronouncements The American Institute of Certified Public Accountants issued Statement of Position (SOP)97-2, "Software Revenue Recognition" in October 1997. SOP 97-2 is not expected to have a material impact on the Company's financial statements. Note 3 - Earnings Per Share The Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share" in February 1997. Implementation of SFAS No. 128 is required for periods ending after December 15, 1997. SFAS No. 128 requires dual presentation of earnings per share (EPS); basic EPS and diluted EPS. Basic EPS excludes dilution and 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 common stock equivalents using the treasury stock method. The following table summarizes the basic EPS and diluted EPS computations for fiscal 1998 and 1997 (in thousands, except per share amounts): 7
8 BMC SOFTWARE, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements <TABLE> <CAPTION> Three Months Ended Nine Months Ended December 31, December 31, 1997 1996 1997 1996 ---- ---- ---- ---- <S> <C> <C> <C> <C> Basic earnings per share: Net earnings $ 64,777 $ 48,101 $ 99,136 $110,459 -------- -------- -------- -------- Weighted average number of common shares 101,560 100,883 101,432 100,582 -------- -------- -------- -------- Basic earnings per share $ 0.64 $ 0.48 $ 0.98 $ 1.10 ======== ======== ======== ======== Diluted earnings per share: Net earnings $ 64,777 $ 48,101 $ 99,136 $110,459 -------- -------- -------- -------- Weighted average number of common shares 101,560 100,883 101,432 100,582 Incremental shares from assumed conversions- Stock options and other 6,450 6,757 6,673 6,254 Unearned restricted stock 33 108 50 85 -------- -------- -------- -------- Adjusted weighted average number of common shares 108,043 107,748 108,155 106,921 -------- -------- -------- -------- Diluted earnings per share $ 0.60 $ 0.45 $ 0.92 $ 1.03 ======== ======== ======== ======== </TABLE> Note 4 - Technology Acquisitions During the quarter ended September 30, 1997, the Company completed an acquisition of a technology company for an aggregate purchase price of approximately $6,995,000, including direct acquisition costs. During the quarter ended June 30, 1997, the Company completed two acquisitions which included DataTools, Inc. and another technology company for an aggregate purchase price of approximately $80,700,000, including direct acquisition costs. The Company funded these acquisitions primarily with cash and to a lesser extent through the issuance of stock options in its common stock. The Company accounted for these transactions using the purchase method and for the three months ended September 30, 1997, and for the three months ended June 30, 1997, respectively, recorded a $3,381,000 and $57,267,000 charge, net of a $1,820,000 and $3,005,000 income tax benefit, for acquired research and development costs. As of December 31, 1997, approximately $5,470,000 of additional consideration and transaction costs relating to these acquisitions remained unpaid. Note 5 - Subsequent Event On January 31, 1998, the Company agreed to acquire BGS Systems, Inc. for approximately $285,000,000. The Company expects to account for this transaction using the pooling of interests method. The acquisition is expected to close within 90 days of January 31, 1998, pending approval from the stockholders of BGS Systems, Inc. and the Securities and Exchange Commission. 8
9 BMC SOFTWARE, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition (continued) Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition This discussion comprises historical information for the periods covered, followed by certain forward looking information and information about certain risks and uncertainties that could affect the Company's future operating results. This discussion should be read in conjunction with the attached consolidated financial statements and notes thereto and with the audited financial statements and notes thereto, and the Management's Discussion and Analysis of Results of Operation and Financial Condition, contained in the Company's Annual Report on Form 10-K for fiscal 1997. A. HISTORICAL INFORMATION RESULTS OF OPERATION The following table sets forth, for the periods indicated, the percentages that selected items in the Condensed Consolidated Statements of Earnings bear to total revenues. These comparisons of financial results are not necessarily indicative of future results. <TABLE> <CAPTION> Percentage of Total Revenues ---------------------------- Three Months Ended Nine Months Ended December 31, December 31, ------------ ------------ 1997 1996 1997 1996 ---- ---- ---- ---- <S> <C> <C> <C> <C> Revenues: Licenses 71.9% 69.3% 69.4% 66.7% Maintenance 28.1 30.7 30.6 33.3 ----- ----- ----- ----- Total revenues 100.0 100.0 100.0 100.0 Operating expenses: Selling and marketing 26.9 26.7 28.4 28.2 Research and development 13.9 13.4 13.8 14.3 Cost of maintenance services and product licenses 9.0 9.1 10.3 10.1 General and administrative 7.9 8.2 7.6 8.5 Acquired research and development costs -- -- 12.7 2.8 ----- ----- ----- ----- Operating income 42.3 42.6 27.2 36.1 Other income 4.2 3.5 4.2 3.6 ----- ----- ----- ----- Earnings before taxes 46.5 46.1 31.4 39.7 Income taxes 13.5 14.0 12.2 12.3 ----- ----- ----- ----- Net earnings 33.0% 32.1% 19.2% 27.4% ===== ===== ===== ===== </TABLE> 9
10 BMC SOFTWARE, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition (continued) REVENUES <TABLE> <CAPTION> Three Months Ended Nine Months Ended December 31, December 31, ------------ ------------ (in thousands) (in thousands) 1997 1996 Change 1997 1996 Change ---- ---- ------ ---- ---- ------ <S> <C> <C> <C> <C> <C> <C> North American license revenues $ 84,945 $ 56,829 49% $233,344 $168,045 39% International license revenues 56,047 47,160 19% 125,595 100,599 25% -------- -------- -------- -------- Total license revenues 140,992 103,989 36% 358,939 268,644 34% Maintenance revenues 55,010 46,071 19% 158,186 133,966 18% -------- -------- -------- -------- Total revenues $196,002 $150,060 31% $517,125 $402,610 28% ======== ======== ======== ======== </TABLE> LICENSE REVENUES The Company's license revenues consist of product license fees, capacity-based license upgrade fees and restructuring fees. Product license fees are generated by (a) the initial licenses of a product on either a per copy or MIPS capacity licensing basis and (b) the licensing of additional copies of a product previously licensed under the Company's per copy, tier-based licensing programs. Capacity-based license upgrade fees are charged when a customer acquires the right to run an already licensed product on additional processing capacity, which may be measured traditionally by central processing unit ("CPU") tier or by the aggregate processing capacity on which the Company's products are installed measured in millions of instructions per second ("MIPS"). These license upgrade fees include fees associated with currently installed additional processing capacity and fees associated with anticipated future additional processing capacity. Restructuring fees are charges which effect an increase in the discounts used to calculate future maintenance and upgrade charges for a customer's installed products. The Company's North American operations generated 60% and 55% of total license revenues in the quarters ended December 31, 1997 and 1996, respectively, and 65% and 63% of total license revenues in the nine-month periods ending on such dates, respectively. Year-over-year growth in North American license revenues in the third quarter of fiscal 1998 over the third quarter of fiscal 1997 was principally from product license fees generated from the Company's client server products and to a lesser extent, increased capacity-based upgrade fees for future capacity. For the nine months ended December 31, 1997, the 39% increase in North American license revenues over the prior year is primarily attributable to product license fees generated from the Company's client-server products and increased capacity-based upgrade fees for both current and future capacity. International license revenues represented 40% and 45% of total license revenues in the quarters ended December 31, 1997 and 1996, respectively, and 35% and 37% of total license revenues in the nine-month periods ending on such dates, respectively. International license revenue growth from the three month period ended December 31, 1996 to the three month period ended December 31, 1997 was derived principally from capacity-based upgrade fees for future capacity, and to a lesser extent, product license fees generated from the Company's client-server products. In the nine months ended December 31, 1997, the 25% increase in International license revenues over the prior year is primarily attributable to 10
11 BMC SOFTWARE, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition (continued) product license fees generated from the Company's client-server products, and to a lesser extent, capacity-based upgrade fees for future capacity. Capacity-based upgrade fees include fees for both current and anticipated future additional processing capacity. These fees accounted for 29% and 28% of total revenues in the quarters ended December 31, 1997 and 1996, respectively, and 32% and 27% of total revenues for the respective nine-month periods. The growth and sustainability of the Company's mainframe-based license revenues are dependent upon these capacity-based upgrade fees, particularly within its largest customer accounts. Most of the Company's largest customers have entered into enterprise license agreements allowing them to install the Company's products on an unspecified number of CPUs, subject to a maximum limit on the aggregate power of the CPUs as measured in MIPS. Substantially all of these transactions include upgrade charges associated with anticipated future additional processing capacity beyond the customer's current usage level and/or a restructuring fee, and some include license fees for additional products. The fees associated with future additional mainframe processing capacity typically represent from one-half to substantially all of the license fees included in the enterprise license transaction. In the quarters ended December 31, 1997 and 1996, the enterprise license fees for future additional processing capacity and license restructurings comprised approximately 25% and 18% of total revenues, respectively, and comprised 25% and 22% of total revenues in the respective nine-month periods. Over the past three fiscal years, the Company has experienced a marked increase in demand from its largest customers for current and anticipated mainframe processing capacity, and the Company expects that it will continue to be dependent upon these license revenue components. With the rapid advancement of client/server technology and customers' needs for more functional and open applications to replace legacy systems, there can be no assurance that the demand for mainframe processing capacity will continue at current levels. Should this trend slow or reverse, it would adversely impact the Company's mainframe-based license revenues and operating results. See "Forward Looking Information and Certain Risks and Uncertainties that Could Affect Future Operating Results." MAINTENANCE REVENUES Maintenance and support revenues represent the ratable recognition of customers' prepaid fees entitling them to product enhancements, technical support services and ongoing compatibility with third-party operating systems, database management systems and applications. Maintenance and support charges are generally 15% to 20% of the list price of the product at the time of renewal, less any applicable discounts. Maintenance revenues also include the ratable recognition of the bundled fees for first-year maintenance services covered by the related perpetual license agreement. The Company continues to invest heavily in product maintenance and support and believes that maintaining its reputation for superior product support is a key component of its value pricing model. Maintenance revenues have increased over the last three fiscal years as a result of the continuing growth in the base of installed products and the processing capacity on which they run. Maintenance fees increase in proportion to the processing capacity on which the products are installed; consequently, the Company receives higher absolute maintenance fees as customers install its 11
12 BMC SOFTWARE, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition (continued) products on additional processing capacity. Due to increased discounting at higher levels of "future MIPS" licensing, however, the maintenance fees per MIPS are often reduced in enterprise license agreements. Historically, the Company has enjoyed high maintenance renewal rates for its mainframe-based products. Should customers migrate from their mainframe applications or find alternatives to the Company's products, however, increased cancellations could occur. This would adversely impact the sustainability and growth of the Company's maintenance revenues. To date, the Company has been successful in extending its traditional maintenance and support pricing model to the client/server market. At this time, there is insufficient historical data to determine whether customers will continue to accept this pricing model and renew their maintenance and support contracts at the levels experienced in the mainframe market. PRODUCT LINE REVENUES The Company's products for the IBM-compatible mainframe environment accounted for 69% and 80% of total revenues in the quarters ended December 31, 1997 and 1996, and 76% and 83% of total revenues, respectively, in the nine-month periods. The database utilities and administrative tools for IBM's IMS DB and DB2 database management systems comprise the largest portion of the Company's mainframe-based revenues. These product lines accounted for 53% of total revenues and 48% of license revenues in the quarter ended December 31, 1997 and 59% and 56% of total and license revenues in the respective nine-month periods. Total revenues and license revenues from these product lines grew 9% and 7%, respectively, in the third quarter of fiscal 1998, and grew 17% and 18% in the nine-month period of fiscal 1998 compared to the comparable prior year periods. The Company's other products for the mainframe environment contributed 16% of total revenues and 14% of license revenues in the third quarter of fiscal 1998, and contributed 17% and 14% of total and license revenues, respectively, in the nine-month period of fiscal 1998. Total revenues for the Company's other mainframe products in the fiscal 1998 third quarter grew by 29% and license revenues grew by 49% in the same period. The Company's client/server product lines primarily comprise the PATROL application and database management solutions, the PATROL DB database administration products and the Company's high-performance database backup and recovery solutions. These product lines contributed 31% of total revenues and 38% of license revenues in the quarter ended December 31, 1997, and 24% and 30% of total and license revenues, respectively, in the nine-month period. Total revenues for these product lines grew 105% and license revenues grew 98% in the third quarter of fiscal 1998, compared to the comparable, prior year quarter. 12
13 BMC SOFTWARE, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition (continued) OPERATING EXPENSES <TABLE> <CAPTION> Three Months Ended Nine Months Ended December 31, December 31, ------------ ------------ (in thousands) (in thousands) 1997 1996 Change 1997 1996 Change ---- ---- ------ ---- ---- ------ <S> <C> <C> <C> <C> <C> <C> Selling and marketing $ 52,836 $ 40,094 32% $146,974 $113,355 30% Research and development 27,152 20,056 35% 71,202 57,748 23% Cost of maintenance services and product licenses 17,599 13,657 29% 53,318 40,793 31% General and administrative 15,433 12,343 25% 39,257 34,021 15% Acquired research and development -- -- N/A 65,473 11,259 482% -------- -------- -------- -------- Total operating expenses $113,020 $ 86,150 $376,224 $257,176 ======== ======== ======== ======== </TABLE> SELLING AND MARKETING EXPENSES Selling and marketing expenses increased year-over-year by 32% or $12,742,000 for the quarter ended December 31, 1997, and by 30% or $33,619,000 for the nine month period ended December 31, 1997. The single largest contributor to this expense growth for both the three month and nine month periods ending December 31, 1997 was personnel costs. Personnel costs increased as the result of a 54% increase in headcount from December 31, 1996 to December 31, 1997, which was primarily attributable to significant increases in the Company's open systems sales representatives, including the 37 sales representatives obtained with the DataTools, Inc. acquisition in the June 1997 quarter. Other contributors to the increase were expenses associated with sales and distributor commissions, accelerated depreciation relating to certain computer equipment, trade shows and travel. As a percentage of total revenues, selling and marketing expenses remained relatively constant ranging from 27% to 28% for the three and nine month periods ended December 31, 1997 and 1996, respectively. RESEARCH AND DEVELOPMENT EXPENSES Research and development expenses increased primarily due to the hiring of additional personnel who were hired to develop new product offerings. Research and development headcount from December 31, 1996 to December 31, 1997 increased by 33%. These expense increases have been partially offset by increases in software capitalization in both the quarter and nine months ended December 31, 1997. For the third quarter of fiscal 1998, the Company capitalized $8,963,000 in software development costs as compared to $5,230,000 in the year-ago quarter. The Company capitalized $27,621,000 and $15,518,000 in software development costs during the nine months ended December 31, 1997 and 1996, respectively. The Company 13
14 BMC SOFTWARE, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition (continued) capitalizes its software development costs when the projects under development reach technological feasibility as defined by SFAS No. 86. The capitalization amounts will fluctuate from period to period in part based upon the status and number of software projects which are in process. Research and development expenses (which are reported net of the above-mentioned capitalized software development costs) as a percentage of total revenues have increased slightly from 13% in the third quarter of fiscal 1997 to 14% in the third quarter of fiscal 1998, and remained constant at 14% in the nine month periods in fiscal 1997 and fiscal 1998. Over the last three fiscal years, the Company has supplemented its internal product development efforts with acquisitions of several companies and technologies, including the base technologies for the PATROL product lines. See "-Acquired Research and Development Costs" below. COST OF MAINTENANCE SERVICES AND PRODUCT LICENSES Cost of maintenance services and product licenses expenses consist of amortization of purchased and internally developed software, costs associated with the maintenance, enhancement and support of the Company's products and royalty fees. This expense line item has increased in the three and nine months ended December 31, 1997 primarily as a result of increases in amortization of internally developed software and in maintenance, enhancement and support activities. Amortization for the Company's capitalized software totaled $4,106,000 and $1,970,000, including accelerated charges discussed below, in the third quarter of fiscal 1998 and 1997, respectively. The Company's amortization of internally developed software costs totaled $13,000,000 and $6,274,000 during the nine months ended December 31, 1997, and 1996, respectively. The Company accelerated the amortization of some of its older products by approximately $1,925,000 during the third quarter of fiscal 1998, versus $750,000 in the third quarter of fiscal 1997, and by approximately $7,564,000 and $2,759,000 in the respective nine-month periods. These software products were not expected to generate future revenues sufficient to justify their carrying value. As a percentage of total revenues, cost of maintenance services and product licenses remained constant at 9% and 10% in the third quarters of fiscal 1998 and 1997 and the nine month periods of fiscal 1998 and fiscal 1997, respectively. GENERAL AND ADMINISTRATIVE EXPENSES The Company's general and administrative expenses increased by $3,090,000 or 25% in the third quarter of fiscal 1998 as compared to the third quarter of fiscal 1997 and increased by $5,236,000 or 15% compared to the prior fiscal years' nine-month period. Professional fees and accelerated depreciation charges associated with certain computer equipment were the primary contributors to the growth in general and administrative expenses for the three and nine months ended December 31, 1997, respectively. As a percentage of total revenues, general and administrative expenses remained constant at 8% in the third quarters of fiscal 1998 and 1997 and decreased from 9% in the nine-month period in fiscal 1997 to 8% in the nine-month period in fiscal 1998. 14
15 BMC SOFTWARE, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition (continued) ACQUIRED RESEARCH AND DEVELOPMENT COSTS The Company completed the acquisitions of stock and assets (including in-process research and development) of certain technology companies for an aggregate purchase price of $80,700,000 during the first quarter of fiscal 1998, and for an aggregate purchase price of $6,995,000 during the second quarter of fiscal 1998, including direct acquisition costs. The Company accounted for these transactions using the purchase method of accounting. During the respective quarters, the Company recorded a $60,272,000 charge ($57,267,000 net of income tax benefits) and a $5,201,000 charge ($3,381,000 net of income tax benefits) for acquired research and development costs. OTHER INCOME For the third quarter of fiscal 1998, other income was $8,246,000, reflecting an increase of 56% over $5,300,000 of other income in the same quarter of fiscal 1997. Other income increased by 51% to $21,542,000 in the nine-month period in fiscal 1998, from $14,233,000 in the nine-month period in fiscal 1997. Other income consists primarily of interest earned on tax-exempt municipal securities, euro bonds, corporate bonds, mortgage securities and money market funds. INCOME TAXES For the third quarter of fiscal 1998, income tax expense was $26,451,000, compared to $21,109,000 for the same quarter in fiscal 1997. Income tax expense was $63,307,000 and $49,208,000 for the nine-month periods in fiscal 1998 and 1997, respectively. The Company's income tax expense represents the federal statutory rate of 35%, plus certain state taxes, reduced by the benefit from the Company's Foreign Sales Corporation, the effect of tax exempt interest earned from cash investments, the effect of tax deductions on certain technology acquisitions and foreign income taxes. Excluding the impact of technology acquisitions, the Company's effective income tax rate for the nine months ended December 31, 1997 has decreased to 30% from 31% during the same period in fiscal 1997. LIQUIDITY AND CAPITAL RESOURCES The Company has financed its growth through funds generated from operations. As of December 31, 1997, the Company had cash, cash equivalents and investment securities of $552,129,000. The Company effectively repurchased 572,000 of its shares during the third quarter of fiscal 1998. As of December 31, 1997, the Company has authorization from its Board of Directors, to acquire up to 3,764,800 shares of its common stock pursuant to the Company's stock repurchase program. However, the Company anticipates that in connection with the proposed acquisition of BGS Systems discussed in Note 4, its Board of Directors will rescind the stock repurchase program. This will be necessary in order to utilize pooling of interests accounting for the transaction. 15
16 BMC SOFTWARE, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition (continued) The Company believes that existing cash balances and funds generated from operations will be sufficient to meet its liquidity requirements for the foreseeable future. B. FORWARD LOOKING INFORMATION AND CERTAIN RISKS AND UNCERTAINTIES THAT COULD AFFECT FUTURE OPERATING RESULTS. The Company's future operating results may vary substantially from period to period. The results of the Company's operating results for the quarter ended December 31, 1997, are not necessarily indicative of results for the following periods, including the fiscal year ended March 31, 1998. Expectations of, and forecasts and projections by the Company and others are by their nature forward looking statements. Numerous important factors, risks and uncertainties affect the Company's operating results and could cause the Company's actual results to differ materially from the results implied by such forward looking statements made by, or on behalf of, the Company. These important factors, risks and uncertainties include, but are not limited to, those described in the following paragraphs and the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1997. The Company's stock price has been and is highly volatile. Future revenues, earnings and stock prices may be subject to wide swings, particularly on a quarterly basis, in response to variations in operating and financial results, anticipated revenue and/or earnings growth rates, competitive pressures and other factors. The stock price of software companies in general, and the Company in particular, is based on expectations of sustained future revenue and earnings growth. Any failure to meet anticipated revenue and earnings levels in a period or any negative change in the Company's perceived long-term growth prospects would likely have a significant adverse effect on the Company's stock price. The growth rates of the Company's license revenues, total revenues, net earnings and earnings per share have accelerated over the last 24 months. The Company's current valuation reflects expectations based in part on these higher rates of growth. The Company may not achieve, in future periods, these relatively higher rates of growth. The timing and amount of the Company's license revenues are subject to a number of factors that make estimation of operating results prior to the end of a quarter extremely uncertain. The Company generally operates 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 the Company's sales are closed at the end of each quarter, and there has been and continues to be a trend toward larger 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 16
17 expected individually significant transaction could cause the Company's revenues and earnings in a period to fall short of expectations. Other factors that may cause significant fluctuations in the Company's quarterly revenues include competition, industry or technological trends, customer budgetary decisions, mainframe processing capacity growth, general economic conditions or uncertainties, mainframe industry pricing and other trends, announcements of new hardware or software products and the timing of price increases. The Company generally does not know whether revenues and earnings will meet expected results until the final days or day of a quarter. The Company's operating expenses are to a large extent fixed in the short term so that the Company has very limited ability to adjust its planned expenses if revenues fail to meet expectations; therefore, if near-term demand for the Company's products weakens in a given quarter, there could be an immediate, material adverse effect on net revenues and operating results, which would likely result in a precipitous drop in its stock price. The Company has historically realized greater revenues and net earnings in the latter half of its fiscal year; the quarter ending December 31 coincides with the end of customers' annual budgetary periods and the quarter ending March 31 coincides with the end of the Company's annual sales plans and fiscal year. For the same reasons, the Company has typically reported lower or flat revenues in the first two quarters of a fiscal year than in the last two quarters of the previous year, resulting in lower operating margins in the first two quarters. The Company historically has generated greater revenues in the third and fourth quarters while maintaining lower rates of expense growth and expanded operating margins. Past financial performance is not a reliable indicator of future performance, and there can be no assurance that this pattern will be maintained. In the nine months ended December 31, 1997, the Company announced several executive management and organizational changes, including its Chief Operating Officer, Senior Vice President, Research and Development, and Senior Vice President, European Sales. The Company may make other management and organizational changes in the future. Organizational and management changes are intended to enhance competitiveness, productivity and execution; however, there can be no assurance that they will produce the desired results. The Company's operating margins (exclusive of charges for acquired research and development costs) have ranged from 37% to 45% in recent quarters, which is at the high-end of the range for peer companies. The Company does not expect future margin expansion. Further, since research and development, sales, support and distribution costs for client/server software products are generally higher than for mainframe products, operating margins will experience more pressure as the mix of the Company's business continues its shift to client/server revenues. The Company is continuing to develop indirect channel relationships to increase its coverage and presence in a cost effective manner. There can be no assurance, however, that this strategy will be successful. If the Company's direct sales force remains the primary channel for its client/server products, its selling and marketing expenses could increase and operating margins could be reduced. Future operating results are also dependent on sustained performance improvement by the Company's international offices, particularly its European operations. Revenue growth by the Company's European operations has been slower than revenue growth in North America, and in an effort to improve its European performance, the Company has recently replaced the head of its European operations. There can be no assurance that the Company will be successful in accelerating the revenue growth of its European operations. The Company's 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. Many systems and applications software vendors are experiencing difficulties internationally. In particular, the recent Asian economic crisis has resulted in customer budget cuts and financial uncertainty. Approximately 5% of the Company's revenues are generated in the Pacific Rim region. The Company derived approximately 69% of its revenues in the third quarter of fiscal 1998 from software products for IBM and IBM-compatible mainframe computers; approximately 53% of total revenues and a higher percentage of earnings were contributed by the Company's high speed utilities for IMS and DB2 administration products. IBM continues to focus on reducing the overall software costs associated with the OS/390 mainframe platform. Further, IBM continues, directly and through third parties, to enhance its 17
18 utilities for IMS and DB2 to provide lower cost alternatives to those provided by the Company 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 twelve months. The Company has traditionally maintained sufficient performance and functional advantages over IBM's base utilities to justify its pricing differential although there can be no assurance that it will continue to maintain such advantages. Fees from enterprise license transactions remain fundamental components of the Company's revenues. In the third quarter of fiscal 1998, enterprise license fees for future additional processing capacity and license restructurings comprised approximately 25% of total revenues. These revenues are dependent upon the Company's customers' continuing to perceive an increasing need to use the Company's existing software products on substantially greater mainframe processing capacity in future periods. The Company believes that the demand for enterprise licenses has been driven by customers' re-commitment over the last 24 to 36 months to the OS/390 mainframe platform for large scale, transaction intensive information systems. Whether this trend will continue is difficult to predict. If the Company's customers' processing capacity growth were to slow and/or if such customers were to perceive alternatives to relying upon the Company's current mainframe products, the Company's revenues would be adversely impacted. Capacity-based upgrade fees associated with both current and future processing capacity contributed 29% of total revenues in the third quarter of fiscal 1998. The charging of upgrade fees based on CPU tier classifications is standard among mainframe systems software vendors, including IBM. While the Company believes its current pricing policies properly reflect the value provided by its products, the pricing of mainframe systems software is under constant pressure from customers and competitive vendors, including IBM. IBM continues to reduce the costs of its mainframe systems software to increase the overall cost competitiveness of its mainframe hardware and software products. IBM also generally charges significantly less for its software products. These actions continue to increase pricing pressures within the mainframe systems software markets. The Company's growth prospects depend heavily on the continued success of its existing client/server products, including PATROL, and those anticipated to be introduced in the future. The client-server systems and application management markets in which the Company operates are far more crowded and competitive than its traditional mainframe systems management markets. The Company has experienced long development cycles and product delays in the past, particularly with some of its client/server products, and expects to have delays in the future. Delays in new mainframe or client/server product introductions or less-than-anticipated market acceptance of these new products are possible and would have an adverse affect on the Company's 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. The enterprise systems management market that the Company's client/server products address is characterized by rapid change and intense competition that continues to increase as vendors within the broader markets converge. Certain of the Company's competitors and potential competitors have significantly greater financial, technical, sales and marketing resources than the Company and greater experience in client/server development and sales. A key factor in determining the success of the Company's products, particularly its client/server offerings, will be their ability to interoperate and perform well with existing and future leading database management systems and other systems software products supported by the Company's products. Maintaining this interoperability has greatly increased the complexity of the Company's product development and support activities. While the Company believes its products that address this market, including those under development, will compete effectively, this market will be relatively unpredictable over the next few years and there can be no assurance that anticipated results will be achieved. Microsoft Corporation has significantly increased its focus on developing operating systems, systems management products and databases that will provide "business-critical" class functionality. Specifically, Microsoft is aggressively promoting its BackOffice(TM) family of software products, including its Window NT Server operating system and its SQL Server relational database management system, as lower cost alternatives to the UNIX operating systems coupled with relational database management systems from Oracle Corporation, Sybase, Inc., Informix Corporation and other vendors. Microsoft could significantly lower software price points in some of the Company's markets, which could place 18
19 additional pricing pressure on the Company. Further, Microsoft could choose to develop competing products for use within Microsoft environments. The Company has invested and intends to continue to invest in the development of systems management products for Windows NT and BackOffice environments, but there are numerous uncertainties associated with the Company's ability to successfully execute this strategy. Litigation seeking to enforce patents, copyrights and trade secrets is increasing in the software industry. There can be no assurance that third parties will not assert that their patent or other proprietary rights are violated by products offered by the Company. Any such claims, with or without merit, can be time consuming and expensive to defend and could have an adverse effect on the Company's business, results of operations, financial position and cash flows. The Company is designing and testing the most current versions of its products to process Year 2000 data without interruption or errors and believes that these versions are substantially Year 2000 compliant. The Company may experience migration costs for customers who are not running current levels of its products. The Company is continually testing its products to assure Year 2000 support and compliance; there can be no assurance, however, that despite such testing, undetected errors or defects will not exist that could cause a product to fail to process Year 2000 data correctly. The Company's products are typically used in high volume information systems that are critical to a customer's operations, so that business interruptions, loss or corruption of data or other major problems could have significant adverse consequences to the customer. At this time, the Company is not aware of any material operational issues or costs associated with Year 2000 compliance of its own products. The Company is also unaware of any potential material liabilities or operational difficulties associated with Year 2000 compliance of its own internal information systems. 19
20 BMC SOFTWARE, INC. AND SUBSIDIARIES PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. 27 Financial Data Schedule (b) Reports on Form 8-K. The Company filed a Form 8-K on February 4, 1998 relating to its expected acquisition of BGS Systems, Inc. (BGS). 20
21 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. Date: February 13, 1998 By: /s/ MAX P. WATSON JR. ----------------- --------------------------------- Max P. Watson Jr. Chairman of the Board, President and Chief Executive Officer Date: February 13, 1998 By: /s/ WILLIAM M. AUSTIN ----------------- --------------------------------- William M. Austin Sr. Vice President and Chief Financial Officer Date: February 13, 1998 By: /s/ KEVIN M. KLAUSMEYER ----------------- --------------------------------- Kevin M. Klausmeyer Chief Accounting Officer 21
22 INDEX TO EXHIBITS <TABLE> <CAPTION> EXHIBIT NO. DESCRIPTION - ----------- ----------- <S> <C> 27 Financial Data Schedule </TABLE>