10-Q 1 ca2qtr10q_edgar.htm FORM 10-Q COMPUTER ASSOCIATES INT'L INC FORM 10-Q

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q

 Ö  Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2001

or

     Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period ended from _____ to _____

Commission File Number 1-9247

Computer Associates International, Inc.
(Exact name of registrant as specified in its charter)

Delaware

13-2857434

(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer Identification Number)

One Computer Associates Plaza, Islandia, New York


11749

(Address of principal executive offices)

(Zip Code)

(631) 342-5224
(Registrant's telephone number, including area code)

Not applicable
(Former name, former address and former fiscal year,
if changed since last report)

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    Ö      No         .


APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of the latest practicable date:

Title of Class

Shares Outstanding

Common Stock

as of November 5, 2001

par value $.10 per share

575,987,468

 

 

 

 

 

COMPUTER ASSOCIATES INTERNATIONAL, INC. AND SUBSIDIARIES




INDEX



PART I.

Financial Information

Page
     

Item 1.

Consolidated Condensed Balance Sheets -

 
 

September 30, 2001 and March 31, 2001

1
     
 

Consolidated Condensed Statements of Operations -

  
 

Three Months Ended September 30, 2001 and 2000

2
     
 

Consolidated Condensed Statements of Operations -

  
 

Six Months Ended September 30, 2001 and 2000

3
     
 

Consolidated Condensed Statements of Cash Flows -

  
 

Six Months Ended September 30, 2001 and 2000

4
     
 

Notes to Consolidated Condensed Financial Statements

5
     

Item 2.

Management's Discussion and Analysis of Financial

  
 

Condition and Results of Operations

8
     

Item 3.

Quantitative and Qualitative Disclosure of Market Risk

19
     

PART II.

Other Information

  
     
     

Item 1.

Legal Proceedings

20
     

Item 4.

Submission of Matters to a Vote of Security Holders

21
     

Item 6.

Exhibits and Reports on Form 8-K

22
     

 

 

Part I.  FINANCIAL INFORMATION

Item 1:

COMPUTER ASSOCIATES INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(unaudited)

(in millions)

September 30,

March 31,
 

      2001      

      2001      

ASSETS:

          

Cash and cash equivalents
Marketable securities
Trade and installment accounts receivable, net
Other current assets

TOTAL CURRENT ASSETS

$

457
86
1,181
     85

1,809

$

763
87
1,622
    171

2,643

  
           

Installment accounts receivable, due after one year, net

 

2,428

  

2,756

  

Property and equipment, net

  

761

  

794

  

Purchased software products, net

  

2,085

  

2,328

  

Goodwill and other intangible assets, net

  

5,154

  

5,400

  

Other assets

  

     212

  

     222

  
           

TOTAL ASSETS

$

12,449

$

14,143

  
           

LIABILITIES AND STOCKHOLDERS' EQUITY:

          

Loans payable and current portion of long-term debt

$

875

$

816

  

Other current liabilities

  

1,420

  

1,470

  

Long-term debt

  

3,071

  

3,639

  

Deferred income taxes

  

1,495

  

1,900

  

Deferred maintenance revenue

  

429

  

538

  

Stockholders' equity

  

  5,159

  

  5,780

  
           

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

$

12,449

$

14,143

  
           
           

See Notes to Consolidated Condensed Financial Statements.

          

1

 

COMPUTER ASSOCIATES INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(unaudited)

(in millions, except per share amounts)

 

For the Three Months
 

        Ended September 30,        
 

     2001         

        2000     

Subscription based fees
Software fees and other
Maintenance
Financing fees
Professional services

REVENUE

$

187
109
248
118
     72

734

  

$

- 
959
274
158
   154

1,545

  
             

Operating Expenses:

            

Selling, general and administrative

  

542

    

645

  

Product development and enhancements

  

171

    

179

  

Commissions and royalties

  

64

    

85

  

Depreciation and amortization

  

   273

    

   279

  
             

TOTAL OPERATING EXPENSES

  

1,050

    

1,188

  
             

(Loss) income before other expenses

  

(316

)

  

357

  
             

Interest expense, net

  

     57

    

     89

  
             

(Loss) income before income taxes

  

(373

)

  

268

  
             

Income taxes

  

    (82

)

  

    130

  
             

NET (LOSS) INCOME

$

  (291

)

$

    138

  
             
             

BASIC (LOSS) EARNINGS PER SHARE

$

   (.50

)

$

    .24

  
             

Basic weighted-average shares used in computation

  

577

    

585

  
             

DILUTED (LOSS) EARNINGS PER SHARE

$

   (.50

)

$

    .23

  
             

Diluted weighted-average shares used in computation

  

577

*

  

592

  
             
             

* Common share equivalents are not included since their effect would be antidilutive.

    
             
             

See Notes to Consolidated Condensed Financial Statements.

            

2

 

COMPUTER ASSOCIATES INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(unaudited)

(in millions, except per share amounts)

 

For the Six Months
 

        Ended September 30,        
 

     2001         

        2000     

Subscription based fees
Software fees and other
Maintenance
Financing fees
Professional services

REVENUE

$

327
215
506
246
   153

1,447

  

$

- 
1,531
532
324
   295

2,682

  
             

Operating Expenses:

            

Selling, general and administrative

  

1,114

    

1,325

  

Product development and enhancements

  

344

    

349

  

Commissions and royalties

  

137

    

150

  

Depreciation and amortization

  

549

    

552

  

1995 Stock Plan

  

       -

    

  (184

)
             

TOTAL OPERATING EXPENSES

  

2,144

    

2,192

  
             

(Loss) income before other expenses

  

(697

)

  

490

  
             

Interest expense, net

  

    126

    

    177

  
             

(Loss) income before income taxes

  

(823

)

  

313

  
             

Income taxes

  

  (190

)

  

    152

  
             

NET (LOSS) INCOME

$

  (633

)

$

    161

  
             
             

BASIC (LOSS) EARNINGS PER SHARE

$

  (1.10

)

$

    .27

  
             

Basic weighted-average shares used in computation

  

577

    

588

  
             

DILUTED (LOSS) EARNINGS PER SHARE

$

  (1.10

)

$

    .27

  
             

Diluted weighted-average shares used in computation

  

577

*

  

599

  
             
             

* Common share equivalents are not included since their effect would be antidilutive.

    
             
             

See Notes to Consolidated Condensed Financial Statements.

            

3

 

COMPUTER ASSOCIATES INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)

(in millions)

For the Six Months
 

Ended September 30,
 

        2001    

   2000    

OPERATING ACTIVITIES:

            

Net (loss) income

$

(633

)

$

161

  

  Adjustments to reconcile net (loss) income to net cash provided

            

  by operating activities:

            

    Depreciation and amortization

  

549

    

552

  

    Deferred income taxes

  

(332

)

  

183

  

    Compensation expense (gain) related to stock and pension plans

  

24

    

(146

)

    Decrease (increase) in noncurrent installment accounts receivable, net

  

333

    

(130

)

    Decrease in deferred maintenance revenue

  

(112

)

  

(48

)

    Changes in other operating assets and liabilities, excluding

            

      effects of acquisitions

  

  489

    

 (300

)

NET CASH PROVIDED BY OPERATING ACTIVITIES

  

318

    

272

  
             

INVESTING ACTIVITIES:

            

Acquisitions, primarily purchased software, marketing rights

            

  and intangibles, net of cash acquired

  

-

    

(164

)

Settlement of purchase accounting liabilities

  

(34

)

  

(326

)

Purchases of property and equipment, net

  

(15

)

  

(41

)

Purchases of marketable securities, net

  

-

    

(7

)

Capitalized development costs and other

  

  (29

)

  

   (23

)

NET CASH USED IN INVESTING ACTIVITIES

  

(78

)

  

(561

)
             

FINANCING ACTIVITIES:

            

Debt repayments, net

  

(492

)

  

(410

)

Dividends paid

  

(23

)

  

(24

)

Exercise of common stock options and other

  

6

    

37

  

Purchases of treasury stock

  

   (47

)

  

  (245

)

NET CASH USED IN FINANCING ACTIVITIES

  

(556

)

  

(642

)
             

DECREASE IN CASH AND CASH EQUIVALENTS BEFORE

            

EFFECT OF EXCHANGE RATE CHANGES ON CASH

  

(316

)

  

(931

)
             

Effect of exchange rate changes on cash

  

    10

    

     (8

)
             

DECREASE IN CASH AND CASH EQUIVALENTS

  

(306

)

  

(939

)
             

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

  

 763

    

1,307

  
             

CASH AND CASH EQUIVALENTS AT END OF PERIOD

$

  457

  

$

   368

  
             
             

See Notes to Consolidated Condensed Financial Statements.

            

4

 

COMPUTER ASSOCIATES INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
SEPTEMBER 30, 2001

NOTE A - BASIS OF PRESENTATION

The accompanying unaudited consolidated condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Rule 10-01 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. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All such adjustments are of a normal recurring nature. Operating results for the six months ended September 30, 2001 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2002. For further information, refer to the consolidated financial statements and footnotes thereto included in Computer Associates International, Inc.'s (the "Registrant" or the "Company") Annual Report on Form 10-K for the fiscal year ended March 31, 2001.


Basis of Revenue Recognition: The Company derives revenue from licensing software products, providing post-contract customer support and professional services. The Company licenses to customers the right to use its enterprise software products pursuant to software license agreements. The timing and amount of license revenue recognized during an accounting period is determined by the nature of the contractual provisions included in the license arrangement with customers. For a detailed description of the Company's revenue recognition policy, refer to Note 1 of the consolidated financial statements included in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2001.


Net (Loss) Earnings Per Share: Basic (loss) earnings per share and diluted loss per share are computed by dividing net (loss) income by the weighted-average number of common shares outstanding for the period. Diluted earnings per share is computed by dividing net income by the sum of the weighted-average number of common shares outstanding for the period plus the assumed exercise of all dilutive securities, such as stock options.

     

(in millions, except per share amounts)

  
     

For the Three Months

  

For the Six Months

  
     

 Ended September 30, 

  

Ended September 30,

  
     

   2001   

    2000   

  

   2001  

   2000  

  

Net (loss) income

Diluted (Loss) Earnings Per Share

$

(291

)

$

138

  

$

(633

)

$

161

  

Weighted-average shares outstanding and

                        

   common share equivalents*

Diluted (Loss) Earnings Per Share



$

577

(.50



)



$

592

 .23

  



$

577

(1.10



)



$

599

 .27

  

Diluted Share Computation

                        

   Weighted-average common shares outstanding
   Weighted-average stock options outstanding, net

 

577
   - 

    

585
    7

    

577
   - 

    

588
  11

  

Weighted-average shares outstanding and

                        

   common share equivalents*

 

 577

    

 592

    

 577

    

 599

  
                         

*

For 2001, common share equivalents are not included since their effect would be antidilutive. If the three and six month periods ended September 30, 2001 had resulted in net income, the weighted-average shares outstanding and common share equivalents would have been 585 million.

  

Cash Dividends: In May 2001, the Company's Board of Directors declared its regular, semi-annual cash dividend of $.04 per share. The dividend was paid on July 5, 2001 to stockholders of record on June 22, 2001.

5

 

COMPUTER ASSOCIATES INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
SEPTEMBER 30, 2001


Statements of Cash Flows: For the six months ended September 30, 2001 and 2000, interest payments were $130 million and $171 million, respectively and income taxes paid were $133 million and $190 million, respectively.


Segment Disclosure: The Company's chief operating decision maker reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenue, by geographic region, for purposes of assessing financial performance and making operating decisions. Accordingly, the Company considers itself to be operating in a single industry segment. The Company is principally engaged in the design, development, marketing, licensing and support of integrated eBusiness computer software solutions operating on a diverse range of hardware platforms and operating systems. The Company does not manage its business by solution or focus area. The Company has no individual customers which constitute a significant concentration.


Comprehensive (Loss) Income: Comprehensive (loss) income includes unrealized gains or losses on the Company's available-for-sale securities and foreign currency translation adjustments included in net (loss) income. The components of comprehensive (loss) income, net of related tax, for the three-month and six month periods ended September 30, 2001 and 2000 are as follows:

     

(in millions)

  
     

For the Three Months

  

For the Six Months

  
     

 Ended September 30, 

  

  Ended September 30,

  
     

   2001   

    2000   

  

    2001  

    2000  

  

Net (loss) income

$

(291

)

$

138

  

$

(633

)

$

161

  

Unrealized loss on marketable securities

  

(3

)

  

-

    

(5

)

  

-

  

Foreign currency translation adjustment

  

   58

    

 (71

)

  

   51

    

 (85

)

Total comprehensive (loss) income

$

(236

)

$

  67

  

$

(587

)

$

  76

  
                         

Accounts Receivable: Trade and installment accounts receivable consist of the following:
 

(in millions)
 

September 30,

March 31,
 

    2001    

    2001    

Current receivables

$

3,226

  

$

3,602

  

Less:

Allowance for doubtful accounts
Deferred revenue - subscription based fees
Unamortized discounts
Deferred maintenance
Deferred professional services






$

(391
(742
(457
(378
    (77
 1,181

)
)
)
)
)






$

(389
(480
(553
(462
    (96
1,622

)
)
)
)
)
               

Non-current receivables

$

5,438

  

$

5,702

  

Less:

Allowance for doubtful accounts
Deferred revenue - subscription based fees
Unamortized discounts
Deferred maintenance





$

(61
(1,793
(661
   (495
2,428

)
)
)
)





$

(60
(1,395
(855
(636
2,756

)
)
)
)

Acquisition-related liabilities: As disclosed in the Company's Form 10-K for the fiscal year ended March 31, 2001, the Company acquired several businesses in fiscal year 2000 and prior. The acquisition related costs and remaining balances are provided below. The Company did not establish additional acquisition related liabilities associated with transactions completed in the first six months of fiscal year 2002 or the full fiscal year 2001 since such liabilities were not material to the consolidated financial statements taken as a whole.

6

COMPUTER ASSOCIATES INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
SEPTEMBER 30, 2001

 

(in millions)
 

Sterling

PLATINUM

Other
 

Duplicate

  

Duplicate

  

Duplicate

  
 

Facilities &

Employee

Facilities &

Employee

Facilities &

Employee
 

Other Costs

Costs

Other Costs

Costs

Other Costs

Costs

Balance at March 31, 1999:

$

-

$

-

$

-

$

-

$

108

$

26

New charges

  

169

    

304

    

268

    

183

    

-

    

12

  

Settlements

  

-

    

-

    

(88

)

  

(115

)

  

(8

)

  

(18

)

Adjustments

  

-

    

-

    

-

    

-

    

(73

)

  

-

  
   

       

    

       

    

       

    

       

    

       

    

       

  

Balance at March 31, 2000:

$

169

  

$

304

  

$

180

  

$

68

  

$

27

  

$

20

  

Settlements

  

(30

)

  

(302

)

  

(53

)

  

(19

)

  

(4

)

  

(7

)

Adjustments

  

(39

)

  

25

    

(28

)

  

(4

)

  

-

    

-

  
   

       

    

       

    

       

    

       

    

       

    

       

  

Balance at March 31, 2001:

$

100

  

$

27

  

$

99

  

$

45

  

$

23

  

$

13

  

Settlements

  

(14

)

  

(4

)

  

(10

)

  

(9

)

  

(1

)

  

(4

)
   

       

    

       

    

       

    

       

    

       

    

       

  

Balance at September 30, 2001:

$

   86

  

$

   23

  

$

   89

  

$

   36

  

$

   22

  

$

     9

  
                                     

The employee costs relate to involuntary termination benefits and the duplicate facilities & other costs relate to operating leases which expire at various times through 2010, negotiated buyouts of the operating lease commitments and other contractually related liabilities. The Sterling and PLATINUM adjustments represent changes in the exit plan from its formulation until its finalization less than one year from the completion of the respective acquisition. The Other acquisition adjustment, which resulted in a reduction to the corresponding liability and related goodwill, represents reductions due to a lower cost of settlement.

NOTE B - 1995 KEY EMPLOYEE STOCK OWNERSHIP PLAN

On June 22, 2000, the Delaware Court of Chancery approved a settlement arising from stock awards made to three executives in June 1998 pursuant to the Company's 1995 Key Employee Stock Ownership Plan. Under the terms of the settlement, the executives returned 4.5 million shares of the Company's stock, of which 3.6 million shares were retained by the Company and the remaining balance was used to pay the legal fees related to the settlement. This settlement resulted in a net non-cash gain of $184 million recorded in the quarter ended June 30, 2000.

NOTE C - RECENT ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"), and SFAS No. 142, "Goodwill And Other Intangible Assets" ("SFAS 142"). SFAS 141 addresses the accounting for acquisitions of businesses and is effective for acquisitions occurring on or after July 1, 2001. SFAS 142 addresses the method of identifying and measuring goodwill and other intangible assets acquired in a business combination, eliminates further amortization of goodwill, and requires periodic evaluations of impairment of goodwill balances. SFAS 142 is effective for fiscal years beginning after December 15, 2001. The Company is currently assessing the impact of adoption of SFAS 141 and SFAS 142. The Company amortized $125 million and $251 million of goodwill for the three and six month periods ended September 30, 2001, respectively, and $128 million and $251 million for the three and six month periods ended September 30, 2000, respectively.

In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144") which supercedes SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS 144 requires, among other things, that long-lived assets be measured at the lower of carrying amount or fair value, less cost to sell, whether reported in continuing operations or in discontinued operations. SFAS 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The Company is currently assessing the impact of adoption of SFAS 144.

7

 

Item 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Statements in this Form 10-Q concerning the company's future prospects and results are "forward looking statements" under the federal securities laws. There can be no assurances that such results will be achieved and actual results could differ materially from forecasts and estimates. Important factors that could cause actual results to differ materially are discussed below in the section "Risks and Uncertainties."

RESULTS OF OPERATIONS

Revenue:

For the three months ended September 30, 2001:

Revenue for the quarter ended September 30, 2001 decreased $811 million, or 52%, from the prior year's comparable quarter. The decrease was primarily a result of the Company's transition to a new business model during the third quarter of fiscal year 2001 as well as weaker economic conditions, which impacted information technology spending. The new business model grants customers flexible contractual terms and conditions, none of which include acceptance terms and conditions, which result in product revenue from such contracts being recognized ratably over the term of the agreements. The amount of total contract value booked and deferred in the quarter ended September 30, 2001, offset by amortization of new business model bookings recorded to revenue in the current quarter, was $279 million. Although weaker economic conditions and the transition to the new business model contributed to the revenue decrease, quantification of the impact these components had on such decrease is not readily determinable. The revenue decrease is also attributable to lower professional services revenue of $82 million.


Subscription based fees totaled $187 million for the quarter ended September 30, 2001 and represents the ratable revenue recognized on contracts executed under the new business model, which was implemented in the third quarter of fiscal year 2001. Since these types of contracts were not offered prior to October 2000, no such revenue was recorded for the quarter ended September 30, 2000.


Software fees and other decreased $850 million, or 89%, from the comparable prior year quarter due to the transition to license arrangements under the new business model that include flexible contractual provisions. These new license arrangements result in the Company recognizing revenue ratably over the license term. The Company recognizes royalties, as well as revenue from arrangements with distribution partners and OEM partners, under the line item "Software fees and other" on the accompanying consolidated condensed statements of operations.


Maintenance revenue for the quarter ended September 30, 2001 was $248 million, a decrease of $26 million, or 9%, from the quarter ended September 30, 2000. The decrease is attributable to agreements executed under the new business model which include maintenance revenue that is bundled with license revenue and, together, the maintenance and license revenue is recognized ratably over the term of the arrangement commencing upon delivery of the currently available software products. Under the new business model, such ratably recognized maintenance and license revenue is included in the "Subscription based fees" line item on the accompanying consolidated condensed statements of operations. Maintenance revenue will continue to decrease as deferred maintenance revenue under the Company's previous business model is amortized over the contract term, partially offset by new revenue earned from customers who elect to continue to receive optional maintenance at the expiration of the original contract term of their agreements.


Financing fees result from the initial discounting to present value of product sales with extended payment terms under the Company's previous business model and the subsequent increase of receivables to the amount due and payable by customers. This accretion of financing revenue on the receivables due in future years represents financing fees. Financing fees decreased $40 million, or 25%, compared to the quarter ended September 30, 2000, due to the discontinuance of offering contracts which were recorded under the previous business model. Financing fees will continue to decrease as they are amortized over the contract life.


8

Item 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Professional services revenue decreased $82 million, or 53%, from the prior year's comparable quarter, primarily as a result of the Company's divestiture in October 2000 of the Sterling Federal Systems Group (FSG), a provider of professional services to governmental agencies, which contributed approximately $42 million to professional services revenue for the quarter ended September 30, 2000. The decrease is also attributable to the Company's shift in focus to professional services engagements that are centered around the Company's products.


Total North American revenue for the second fiscal quarter decreased 54% over the prior year's second fiscal quarter as a result of the Company's transition to the new business model. North American revenue represented 67% and 70% of revenue for the September 2001 and September 2000 quarters, respectively.

   

North

   

Quarter Ended

  

America

  

International
         

September 30, 2001

  

$  493

  

$  241

September 30, 2000

  

  1,082 

  

    463

Price changes did not have a material impact on this quarter or the prior year's second fiscal quarter.

For the six months ended September 30, 2001:


Revenue for the six months ended September 30, 2001 decreased $1.235 billion, or 46%, from the prior year's comparable period. The decrease was primarily a result of the Company's transition to a new business model as well as weaker economic conditions, which impacted information technology spending. The amount of total contract value booked and deferred in the six months ended September 30, 2001, offset by amortization of new business model bookings recorded to revenue in the six month period, was $641 million. Although weaker economic conditions and the transition to the new business model contributed to the revenue decrease, quantification of the impact these components had on such decrease is not readily determinable. The revenue decrease is also attributable to lower professional services revenue of $142 million.


Subscription based fees totaled $327 million for the six months ended September 30, 2001 and represents the ratable revenue recognized on contracts executed under the new business model. Since these types of contracts were not offered prior to October 2000, no such revenue was recorded for the comparable period ended September 30, 2000.


Software fees and other decreased $1.316 billion, or 86%, from the comparable prior year period due to the transition to license arrangements under the new business model that include flexible contractual provisions. These new license arrangements result in the Company recognizing revenue ratably over the license term.


Maintenance revenue for the six months ended September 30, 2001 was $506 million, a decrease of 5% from the six month period ended September 30, 2000. The decrease is attributable to agreements executed under the new business model which include maintenance revenue that is bundled with license revenue and, together, the maintenance and license revenue is recognized ratably over the term of the arrangement commencing upon delivery of the currently available software products. Under the new business model, such ratably recognized maintenance and license revenue is included in the "Subscription based fees" line item on the accompanying consolidated condensed statements of operations.


Financing fees result from the initial discounting to present value of product sales with extended payment terms under the Company's previous business model and the subsequent increase of receivables to the amount due and payable by customers. This accretion of financing revenue on the receivables due in future years represents financing fees. Financing fees decreased $78 million, or 24%, from the prior year's comparable period, due to the discontinuance of offering contracts which were recorded under the previous business model.


Professional services revenue decreased $142 million, or 48%, from the prior year's comparable period, primarily as a result of the Company's divestiture of FSG, which contributed approximately $80 million to professional

9

 

Item 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

services revenue for the fiscal year to date period ended September 30, 2000. The decrease is also attributable to the Company's shift in focus to professional services engagements that are centered around the Company's products.

Total North American revenue for the six months ended September 30, 2001 decreased 48% over the prior year's comparable period as a result of the Company's transition to the new business model. North American revenue represented 67% and 70% of revenue for the year to date periods ended September 2001 and September 2000, respectively.

   

North

   

Six Months Ended

  

America

  

International
         

September 30, 2001

  

$  963

  

$  484

September 30, 2000

  

  1,866 

  

    816

Price changes did not have a material impact year to date on fiscal year 2002 or in the comparable period on fiscal year 2001.

Costs and Expenses:

For the three months ended September 30, 2001:

Selling, general and administrative expenses for the second quarter of fiscal year 2002 decreased $103 million, or 16%, compared to the comparable prior year quarter. The decrease was largely attributable to the Company's emphasis on overall cost control measures related to a reduction in the Company's headcount of approximately 3,000, which included the divestiture of FSG in the third quarter of fiscal year 2001 that contributed approximately $38 million of such expenses in the prior fiscal year's comparable quarter.


Net product development and enhancement expenditures decreased $8 million, or 4%, for the second fiscal quarter of 2002 as compared to the prior year's second fiscal quarter as the Company emphasized its cost controls. However, as a percentage of operating expenses, net research and development expenditures increased as compared with the prior year's comparable quarter as the Company continued its focus on product development and enhancements, with an emphasis on adapting and enhancing products for the distributed processing and IBM's z/OS environments, as well as a broadening of the Company's e-commerce product offerings.


Commissions and royalties decreased $21 million, or 25%, for the second quarter of this fiscal year as compared with the prior year's comparable quarter. The decrease was principally the result of a reduction in contract bookings associated with the weaker economic environment for information technology spending.


Depreciation and amortization expense in the second fiscal quarter of 2002 decreased $6 million, or 2%, over the second fiscal quarter of the prior year. The decrease was a result of scheduled reductions in the amortization of intangible assets associated with past acquisitions.


Net interest expense decreased $32 million, or 36%, for the second fiscal quarter of 2002 compared to last year's second fiscal quarter. Of the reduction, $16 million was a result of the decrease in the average variable interest rate and $16 million was due to the decrease in average debt outstanding.

For the six months ended September 30, 2001:

Selling, general and administrative expenses for the first half of fiscal year 2002 decreased $211 million, or 16%, compared to the comparable prior year period. Consistent with the second fiscal quarter, the decrease was largely attributable to the Company's emphasis on overall cost control measures related to a reduction in the Company's overall headcount of approximately 3,000, which included the divestiture of FSG in the third quarter of fiscal year 2001 which contributed approximately $72 million of such expenses in the prior fiscal year's comparable quarter, and a $31 million charge taken in the prior year first fiscal quarter relating to a client bankruptcy.


10

 

Item 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Net product development and enhancement expenditures decreased $5 million, or 1%, for the six month period ended September 30, 2001, compared to the prior year's comparable period. The Company continued its focus on product development and enhancements, with an emphasis on adapting and enhancing products for the distributed processing and IBM's z/OS environments, as well as a broadening of the Company's e-commerce product offerings.


Commissions and royalties decreased $13 million, or 9%, for the first two quarters of fiscal year 2002 as compared with the prior year's comparable period. The decrease was principally the result of a reduction in contract bookings associated with the weaker economic environment for information technology spending.


Depreciation and amortization expense in the first two quarters of fiscal year 2002 remained consistent with the first two quarters of fiscal year 2001, and was primarily comprised of amortization of intangible assets associated with past acquisitions.


In June 2000, the Company recorded a special non-cash net gain of $184 million related to the settlement of litigation associated with stock awards made to three Company executives in June 1998 pursuant to the Company's 1995 Key Employee Stock Ownership Plan. The terms of the settlement provided for the executives to return a portion of their shares to the Company.


On a year to date basis, net interest expense decreased $51 million, or 29%, compared to fiscal year 2001. Of the reduction, $32 million was a result of the decrease in debt outstanding and $19 million was due to the decrease in the average variable interest rate.


Operating Margins:

For the second quarter of fiscal year 2002, the pretax loss was $373 million as compared with the pretax income of $268 million in the prior year's comparable quarter. On a year to date basis, the pretax loss was $823 million as compared with the pretax income of $313 million, inclusive of a $184 million gain arising from the settlement of litigation associated with stock awards pursuant to the Company's 1995 Key Employee Stock Ownership Plan, partially offset by a $31 million write-off associated with a client bankruptcy. The net loss in the September 2001 quarter and on a year to date basis was primarily related to a reduction in revenue associated with the Company's transition to the new business model, offset partially by a reduction in expenses of $170 million or 13%, for the September 2001 quarter compared to the September 2000 quarter, and a reduction in expenses of $99 million, or 4%, for the year to date period ended 2001 when compared to 2000. The Company's consolidated effective tax rate was 22% and 48.5% for the quarters ended September 30, 2001 and 2000, respectively. The reduced tax rate (benefit) in the current year's second fiscal quarter reflects the greater impact of non-deductible amortization expense on the Company's annual estimated loss.

PRO FORMA RESULTS OF OPERATIONS

To provide comparable financial results, management's discussion and analysis is supplemented with separate pro forma financial information presented below in order to give effect to the purchase of PLATINUM and Sterling under the assumption that the Company, PLATINUM and Sterling were under the new business model since their inception. Pro forma results are calculated by adjusting prior period revenue recorded under the old business model to revenue on a ratable basis under the new business model. While these results may not be indicative of operations had these acquisitions actually occurred on that date and had the Company historically been operating under the new business model, the Company believes they provide a meaningful basis for comparison. Professional services revenue and total expenses are identical under both the new and previous business models; therefore, management's discussion and analysis of these captions has not been repeated under the pro forma results of operations. The following pro forma measures may not be comparable to similarly titled measures reported by other companies.

11

 

Item 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

For the three months ended September 30, 2001:


Revenue:

Pro forma product and other revenue increased $127 million, or 10%, over the prior year's comparable quarter. Total pro forma revenue increased $45 million, or 3%, over last year's comparable quarter. The increase was attributable primarily to the ratable recognition of revenue from contracts entered into during the prior twelve month period that previously were deferred. Total pro forma revenue benefited from an increase in product and other revenue, partially offset by a decrease in professional services revenue of $82 million.

   

Product

 

Professional

Quarter Ended

  

and Other

  

   Services   
         

September 30, 2001

  

$  1,370

  

$  72

September 30, 2000

  

    1,243

  

    154  

Total North American pro forma revenue for the second fiscal quarter grew $23 million, or 3%, over the prior year's second fiscal quarter. Total international pro forma revenue for the second fiscal quarter grew $22 million, or 4%, over the prior year's second fiscal quarter. These increases resulted from continued growth in distributed platform product fees. North American pro forma revenue represented 64% of revenue for both the September 2001 and September 2000 quarters.

   

North

   

Quarter Ended

  

America

  

International
         

September 30, 2001

  

$  918

  

$  524

September 30, 2000

  

    895

  

    502

The pro forma revenue for the quarter ended September 30, 2001 of $1.442 billion was determined by increasing the reported revenue of $734 million by the license fee amortization of $627 million, $40 million, and $41 million related to the Company, Sterling and PLATINUM, respectively, which represents the amortization of license revenue recognized up-front for direct product sales in prior fiscal years had the Company, Sterling and PLATINUM been recognizing revenue on a ratable basis since their inception.

Operating Margins:


Excluding acquisition amortization, pro forma net income increased $130 million, or 57%, to $359 million for the second quarter of fiscal year 2002. The increase was attributable to an increase in revenue of $45 million generated from contracts previously deferred, as well as the Company's emphasis on cost control, including a commitment to manage overall headcount. Excluding acquisition amortization, the Company's assumed effective tax rate was 37.5% for both of the September 2001 and September 2000 fiscal quarters.

For the six months ended September 30, 2001:

Revenue:

Pro forma product and other revenue increased $303 million, or 12%, to $2.729 billion for the year to date period ending September 30, 2001. Total pro forma revenue increased $161 million, or 6%, over the prior year's comparable period. Consistent with the second quarter, the increase was attributable primarily to the ratable recognition of revenue from contracts entered into during the prior twelve month period that previously were deferred. Total pro forma revenue benefited from an increase in product and other revenue, partially offset by a decrease in professional services revenue of $142 million.

12

 

Item 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

   

Product

 

Professional

Six Months Ended

  

and Other

  

   Services   
         

September 30, 2001

  

$  2,729

  

$  153 

September 30, 2000

  

    2,426

  

   295

Total North American pro forma revenue for the first two quarters of fiscal year 2002 grew $101 million, or 6%, over the comparable period in fiscal year 2001. Total international pro forma revenue increased $60 million, or 6%, for the two quarters ended September 30, 2001 over the prior year's comparable period. These increases resulted from continued product growth, partially offset by a reduction in professional services revenue. North American pro forma revenue represented 64% of revenue for both the September 2001 and September 2000 year to date periods.

   

North

   

Six Months Ended

  

America

  

International
         

September 30, 2001

  

$ 1,833

  

$ 1,049 

September 30, 2000

  

   1,732

  

     989

The pro forma revenue for the six months ended September 30, 2001 of $2.882 billion was determined by increasing the reported revenue of $1.447 billion by the license fee amortization of $1.273 billion, $80 million, and $82 million related to the Company, Sterling and PLATINUM, respectively, which represents the amortization of license revenue recognized up-front for direct product sales in prior fiscal years had the Company, Sterling and PLATINUM been recognizing revenue on a ratable basis since their inception.

Operating Margins:


For the first half of fiscal year 2002, pro forma net income, excluding acquisition amortization, increased $252 million, or 59%, to $682 million from $430 million for the first half of fiscal year 2001, excluding acquisition amortization and special items ($184 million gain arising from the settlement of litigation associated with stock awards pursuant to the Company's 1995 Key Employee Stock Ownership Plan, partially offset by a $31 million write-off associated with a client bankruptcy). The increase was attributable to increased revenue generated from contracts previously deferred as subscription based revenues as well as the Company's emphasis on cost control, including a commitment to manage overall headcount. Excluding acquisition amortization, the Company's assumed effective tax rate was 37.5% for the year to date periods ended September 30, 2001 and 2000.

IN-PROCESS RESEARCH AND DEVELOPMENT:


There have been no material changes in the Company's assumptions underlying the estimates used in valuing in-process research and development, and as such, the discussion under the caption "In-Process Research and Development" remains unchanged from that which was included in the Company's Form 10-K for the year ended March 31, 2001.

LIQUIDITY AND CAPITAL RESOURCES:


The Company's cash, cash equivalents, and marketable securities decreased approximately $114 million from the June 30, 2001 balance of $657 million to $543 million as of September 30, 2001. For the quarter ended September 2001, cash from operations and cash on hand as of June 30, 2001 was used to repay over $180 million in outstanding debt and to fund stock repurchases of approximately $43 million. Net cash provided from operations for the quarters ended September 30, 2001 and 2000 was $164 million and $125 million, respectively.

For the six months ended September 30, 2001, cash, cash equivalents, and marketable securities decreased approximately $307 million. Cash from operations of $318 million and cash on hand as of March 31, 2001 was used to repay over $490 million in outstanding debt and to fund stock repurchases of approximately $47 million.

13

Item 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

The Company's bank credit facilities consist of a $2 billion four-year term loan and a $1 billion four-year revolving credit facility. During the quarter the Company repaid its 75 million British Pound Sterling denominated 364-day loan. As of September 30, 2001, $1.75 billion remained outstanding under the four-year term loan and there were no drawings under the four-year revolving credit facility. The interest rates of such debt are determined based on a ratings grid, which applies a margin to the prevailing London InterBank Offered Rate ("LIBOR").

In addition, the Company has established a $1 billion U.S. Commercial Paper ("CP") program to refinance some of its debt at more attractive interest levels. As of September 30, 2001, $276 million was outstanding under the CP program bearing an average interest rate of approximately 3.64%. The Company also utilizes other financial markets in order to maintain its broad sources of liquidity. In fiscal year 1999, $1.75 billion of unsecured Senior Notes were issued in a transaction governed by Rule 144A under the Securities Act of 1933. Amounts borrowed, rates and maturities for each issue were $575 million at 6.25% due April 15, 2003, $825 million at 6.38% due April 15, 2005 and $350 million at 6.50% due April 15, 2008. As of September 30, 2001, $128 million was outstanding under the Company's 6.77% Senior Notes. These Notes call for annual repayment of $64 million each April until final maturity in 2003.


Unsecured and uncommitted multi-currency lines of credit are available to meet any short-term working capital needs for subsidiaries operating outside the U.S. These lines total U.S. $51 million, of which $19 million was drawn as of September 30, 2001.


Debt ratings for the Company's senior unsecured notes and its bank credit facilities are BBB+ and Baa1 from Standard & Poor's and Moody's Investor Services, respectively.

As of September 30, 2001, the cumulative number of shares purchased under the Company's various open market Common Stock repurchase programs was approximately 168 million. The remaining number of shares authorized for repurchase was approximately 32 million.


The Company expects its long-standing history of providing extended payment terms to customers to continue under the new business model.


Cash from operations is expected to be lower in the third quarter of fiscal year 2002 as compared to the third quarter of fiscal year 2001 due to the collection of one-time up-front payments of approximately $250 million in the third quarter of fiscal year 2001. Collections of this magnitude are not expected during the third quarter of fiscal year 2002.

On October 11, 2001, the Company announced that it is reducing its worldwide headcount by approximately 900 across all functional areas. These reductions, which are primarily in North America, reflect a five percent decrease in the Company's worldwide staffing levels. As a result, the Company will incur severance related costs of approximately $20 million, the majority of which will be paid during the third quarter of fiscal year 2002.


Capital resource requirements as of September 30, 2001 consisted of lease obligations for office space, computer equipment, mortgage or loan obligations, amounts due as a result of product and company acquisitions, and severance related payments as noted above. It is expected that existing cash, cash equivalents, marketable securities, the availability of borrowings under credit lines and cash provided from operations will be sufficient to meet ongoing cash requirements.

RISKS AND UNCERTAINTIES:


Current and potential stockholders should consider carefully the risk factors described below. Any of these factors, or others, many of which are beyond the Company's control, could adversely affect the Company's revenue, profitability or cash flow in the future.

14

 

Item 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS


Operating results and revenue are subject to fluctuations caused by many factors.


Quarterly and annual results of operations are affected by a number of factors, including those listed below, which in turn could adversely affect the Company's revenue, profitability or cash flow in the future. These factors include:

-

Demand for products and services;

-

Length of sales cycle;

-

Customer implementation of the Company's products;

-

Magnitude of price and product competition;

-

Introduction of new hardware;

-

General economic conditions in countries in which customers do a substantial amount of business;

-

Customer budgets for hardware and software;

-

Ability to develop and introduce new or enhanced versions of the Company's products;

-

Changes in foreign currency exchange rates;

-

Ability to control costs;

-

The size of licensing transactions;

-

Ability to retain qualified personnel; and

-

Reaction of customers to the new business model.

Any of the foregoing factors may cause the Company's operating expenses to be disproportionately high or cause its revenue and operating results to fluctuate. As a consequence, the Company's business, financial condition and operating results could be adversely affected.


The computer software business is highly competitive.


The market in which the Company competes is marked by rapid and substantial technological change, the steady emergence of new companies and products, evolving industry standards and changing customer needs. To remain competitive, the Company must develop new products and continue to enhance existing products. The Company may be unsuccessful in its ability to develop new releases or new products that meet the needs of its customers in light of competitive alternatives available in the market. In addition, the introduction of new products or versions of existing products may not meet with customer acceptance or may be delayed. The Company's inability to bring new products and enhancements to existing products to the market in a timely manner or the failure for these products to achieve market acceptance could have a material adverse effect on its business, financial condition and operating results.


The software business is marked by easy entry and large entrenched businesses.


Many companies with whom the Company competes, including IBM, Sun, HP, Compaq and other large computer manufacturers, have substantial resources, a larger installed base of customers in any particular market niche, as well as the ability to develop and market software programs similar to and competitive with the products offered by the Company. Competitive products are also offered by numerous independent software companies that specialize in specific aspects of the highly fragmented software industry. Some, like Microsoft, Oracle Corporation and SAP AG, are the leading developers and vendors in their specialized markets. In addition, new companies enter the market on a frequent and regular basis, offering products that compete with those offered by the Company. Increased competition also results from consolidation of existing companies within the industry. Additionally, many customers historically have developed their own solutions that compete with those offered by the Company. Competition from any of these sources can result in price reductions, or displacement of the Company's products, which could have a material adverse effect on the Company's business, financial condition and operating results.


The Company's products must remain compatible with ever-changing operating environments.


IBM, HP, Sun, Compaq and Microsoft are by far the largest suppliers of systems software and, in most cases, are the manufacturers of the computer hardware systems used by most of the Company's clients. Historically, these operating system developers have modified or introduced new operating systems, systems software and computer hardware. Such new products could in the future incorporate features which perform functions currently

15

Item 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

performed by the Company's products or could require substantial modification of the Company's products to maintain compatibility with these companies' hardware or software. Although the Company has to date been able to adapt its products and its business to changes introduced by hardware manufacturers and system software developers, there can be no assurance that it will be able to do so in the future. Failure to adapt the Company's products in a timely manner to such changes or customer decisions to forego the use of the Company's products in favor of those with comparable functionality contained either in the hardware or operating system could have a material adverse effect on its business, financial condition and operating results.


Future product development is dependent upon access to third-party operating systems.


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


Third-party microcode could impact product development.


The Company anticipates ongoing use of microcode or firmware provided by hardware manufacturers. Microcode and firmware are essentially software programs in hardware form and are therefore less flexible than other types of software. The Company believes that such continued use will not have a significant impact on the Company's operations and that its products will remain compatible with any changes to such code. However, there can be no assurance that future technological developments involving such microcode will not have an adverse impact on the Company's business, financial condition and operating results.


Certain software is licensed from third parties.


Some of the Company's products contain software licensed from third parties. Some of these licenses may not be available to the Company in the future on terms that are acceptable or allow its products to remain competitive. The loss of these licenses or the ability to maintain any of them on commercially acceptable terms could delay development of future products or enhancement of existing products. This could adversely affect the Company's business, financial condition and operating results.


Customer decisions are influenced by general economic conditions.


The Company's products are designed to improve the productivity and efficiency of its customers' information processing resources. In a recessionary environment, the Company's products are often a reasonable economic alternative for customers faced with the prospect of incurring expenditures to increase their existing information processing resources. However, a general or regional slowdown in the world economy could cause customers to delay or forego decisions to license new products or upgrades to their existing environments and this could adversely affect the Company's business, financial condition, and operating results.


The markets for some or all the Company's key product areas may not continue to grow.


The Company has identified six product focus areas: Enterprise Management, eBusiness Security, eBusiness Storage, eBusiness Transformation and Integration, Portal and Knowledge Management, and Predictive Analysis and Visualization. Some or all of these areas may not continue to grow, may not grow at their current rates, may decline in growth or customers may decline or forego use of products in some or all of these focal areas. This is particularly true in newly emerging areas, like portal and knowledge management and predictive analysis and visualization. A decline in these focus areas could result in decreased demand for the Company's products, which would adversely impact its business, financial condition and operating results.

16

Item 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Fiscal Year 2002 will be the first full fiscal year operating under the Company's new business model.


The Company's new business model affords customers greater flexibility in licensing transactions. For example, under the new business model, the Company licenses software on a month-to-month or other short-term basis in order to allow customers the opportunity to try the Company's software solutions without committing to a multi-year license obligation. Transactions such as these increase the risk that customers will not fully implement the Company's software and will not enter into a long-term relationship with the Company. This could adversely affect the Company's business, financial condition and operating results. This effect could be diminished if customers elect cost certainty by committing to longer contract periods.


Failure to protect the Company's intellectual property rights would weaken its competitive position.


Future success of the Company is dependent upon its proprietary technology. The Company protects its proprietary information through the use of patent, copyright, trademark, trade secret laws, confidentiality procedures and contractual provisions. Notwithstanding the Company's efforts to protect its proprietary rights, policing unauthorized use or copying of its proprietary information is difficult, unauthorized use or copying occurs from time to time, and litigation to enforce intellectual property rights could result in significant costs and diversion of resources. Moreover, the laws of some foreign jurisdictions do not afford the same degree of protection to the Company's proprietary rights as do the laws of the United States. For example, "shrink-wrap" or "click-on" licenses may be unenforceable in whole or in part in some jurisdictions in which the Company operates. In addition, patents the Company has obtained may be circumvented, challenged, invalidated or designed around by other companies. The Company's inability to adequately protect its intellectual property for these or other reasons could adversely affect its business, financial condition and operating results.


Third parties could claim that the Company's products infringe on their intellectual property rights.


From time to time the Company receives notices from third parties claiming infringement on various forms of their intellectual property. Investigation of these claims, whether with or without merit, can be expensive and could affect development, marketing or shipment of the Company's products. As the number of software patents issued increases, it is likely that additional claims, with or without merit, will be asserted. Defending against such claims is time-consuming and could result in significant litigation expense or settlement with unfavorable terms that could adversely affect the Company's business, financial condition and operating results.


The success of the Company's international operations is subject to many factors.


International revenue has historically represented approximately one-third of the Company's total worldwide revenue. Continued success in selling the Company's products outside of the United States depends on a variety of factors, including the following:

-

Reorganizations of the sales force;

-

Fluctuations in foreign exchange currency rates;

-

Staffing key managerial positions;

-

General economic conditions in foreign countries;

-

Political instability; and

-

Trade restrictions such as tariffs, duties or other controls affecting foreign operations.

Increase in tariffs, the imposition of trade restrictions or other factors may adversely affect the Company's business, financial condition and operating results.


Fluctuations in foreign currencies could result in transaction losses.


Most of the revenue and expenses of the Company's foreign subsidiaries are denominated in local currencies. Due to the substantial volatility of currency exchange rates, it is not possible to predict the effect of exchange rate fluctuations on the Company's future operating results. Given the relatively long sales cycle that is typical for many of the Company's products, foreign currency fluctuations could result in substantial changes in the foreign currency impact on these transactions. Additionally, deterioration of the exchange rate of foreign currencies against the U.S. dollar can affect the Company's ability to increase its revenue within those markets, all of which may adversely impact the Company's business, financial condition and operating results.

17


Item 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Changes to compensation of the Company's sales organization.


With the introduction of the new business model, the Company revised its compensation plan for the sales organization effective April 1, 2001. The new compensation plan is in alignment with the new business model objectives of providing client flexibility and satisfaction. The compensation plan may encourage behavior not anticipated or intended as it is implemented, which could adversely affect the Company's business, financial condition and operating results.


The Company may become dependent upon large transactions.


The Company has historically been dependent upon large dollar enterprise transactions with individual customers. As a result of the flexibility afforded by the new business model, the Company anticipates that there will be fewer of these transactions in the future. There can be no assurances, however, that the Company will not be reliant on large dollar enterprise transactions in the future and the failure to close such transactions could adversely affect the Company's business, financial conditions and operating results.


A large portion of business is consummated at the end of each quarter.


Historically, a significant percentage of the Company's quarterly transactions are finalized in the last few days of the quarter, which may impact financial performance. One of the intended benefits the Company anticipates from introduction of the new business model will be a more predictable revenue stream throughout the quarter. As customers continue to transition to the new business model, there are likely to be a large number of transactions that will be consummated in the last few days of the quarter, with the risk that some of these may not become final. Failure to finalize transactions in the last few days of the quarter could adversely affect the Company's business, financial condition and operating results.


Growth depends upon successful integration of acquisitions.


The Company's growth strategy is based upon internal development of technology, selective acquisitions and integration of such acquisitions into ongoing operations. Implementation of this growth strategy may result in strains on the Company's management team, internal systems and financial resources. Difficulties encountered in successfully integrating acquired companies and products may adversely affect the Company's business, financial condition and operating results.


The Company's stock price may continue to be volatile.


The Company's stock price is subject to significant fluctuations in response to variations in quarterly operating results, the gain or loss of significant contracts, changes in earnings estimates by analysts, announcements of technological innovations or new products by the Company or our competitors, changes in domestic and international economic and business conditions, general conditions in the software and computer industries and other events or factors. In addition, the stock market in general has experienced extreme price and volume fluctuations that have affected the market price of many companies in industries similar or related to the Company's and that have been unrelated to the operating performance of these companies. These market fluctuations have in the past adversely affected and may continue to adversely affect the market price of the Company's common stock.


Acts of terrorism or war may adversely affect the Company's business.


Acts of terrorism, acts of war and other unforeseen events, may cause damage or disruption to our properties, business, employees, suppliers, distributors, resellers, and customers which could have an adverse effect on the Company's business, financial condition and operating results. Such events may also result in an economic slowdown in the United States or elsewhere, which could adversely affect the Company's business, financial condition and operating results.

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Item 3:

QUANTITATIVE AND QUALITATIVE DISCLOSURE
OF MARKET RISK

Interest Rate Risk

The Company's exposure to market rate risk for changes in interest rates relates primarily to the Company's investment portfolio, debt, and installment accounts receivable. The Company has a prescribed methodology whereby it invests its excess cash in debt instruments of government agencies and high quality corporate issuers (Standard & Poor's single "A" rating and higher). To mitigate risk, many of the securities have a maturity date within one year, and holdings of any one issuer excluding the U.S. Government do not exceed 10% of the portfolio. Periodically, the portfolio is reviewed and adjusted if the credit rating of a security held has deteriorated. The Company does not utilize derivative financial instruments.


The Company maintains a blend of both fixed and floating rate debt instruments. As of September 30, 2001, the Company's outstanding debt approximated $3.9 billion, with approximately $1.9 billion in fixed rate obligations. If market rates were to decline, the Company could be required to make payments on the fixed rate debt that would exceed those based on current market rates. Each 25 basis point decrease in interest rates would have an associated annual opportunity cost of approximately $5 million. Each 25 basis point increase or decrease in interest rates would have an approximate $5 million annual effect on variable rate debt interest based on the balances of such debt as of September 30, 2001.


Under the Company's previous business model, the Company offered financing arrangements with installment payment terms in connection with its software solution sales. The aggregate contract value includes an imputed interest element, which can vary with the interest rate environment. Each 25 basis point increase in interest rates would have an associated annual opportunity cost of approximately $15 million.


Foreign Currency Exchange Risk


The Company conducts business on a worldwide basis through subsidiaries in 45 countries. The Company is therefore exposed to movement in currency exchange rates. As part of its risk management strategy and consistent with prior years, the Company did not enter into any foreign exchange derivative transactions. In addition, the Company manages its level of exposure by denominating international sales and payments of related expense in the local currency of its subsidiaries. A 1% decline in all foreign currencies against the U.S. dollar would have an insignificant effect on the Company's net (loss) income.


Equity Price Risk


The Company has minimal investments in marketable equity securities of publicly-traded companies. As of September 30, 2001, these investments were considered available-for-sale with any unrealized gains or losses deferred as a component of stockholders' equity. It is not customary for the Company to make investments in equity securities as part of its investment strategy.

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PART II. OTHER INFORMATION

Item 1: Legal Proceedings

The Company, Charles B. Wang, Sanjay Kumar and Russell M. Artzt are defendants in a number of shareholder class action lawsuits, the first of which was filed July 23, 1998, alleging that a class consisting of all persons who purchased the Company's stock during the period January 20, 1998 until July 22, 1998 were harmed by misleading statements, representations and omissions regarding the Company's future financial performance. These cases, which seek monetary damages in an unspecified amount, have been consolidated into a single action (the "Shareholder Action") in the United States District Court for the Eastern District of New York ("NY Federal Court"). The NY Federal Court denied the defendants' motion to dismiss the Shareholder Action, and the parties currently are engaged in discovery. Although the ultimate outcome and liability, if any, cannot be determined, management, after consultation and review with counsel, believes that the facts in the Shareholder Action do not support the plaintiffs' claims and that the Company and its officers and directors have meritorious defenses.


In addition, three derivative actions, the first of which was filed on July 30, 1998, alleging misleading statements and omissions similar to those alleged in the Shareholder Action were brought in the NY Federal Court on behalf of the Company against a majority of the Company's directors. An additional derivative action on behalf of the Company, alleging that the Company issued 14.25 million more shares than were authorized under the 1995 Key Employee Stock Ownership Plan (the "1995 Plan"), also was filed in the NY Federal Court. These derivative actions have been consolidated into a single action (the "Derivative Action") in the NY Federal Court. The Derivative Action has been stayed. Lastly, a derivative action on behalf of the Company was filed in the Chancery Court in Delaware (the "Delaware Action") on September 15, 1998 alleging that 9.5 million more shares were issued to the three 1995 Plan participants than were authorized under the 1995 Plan. The Company and its directors who are parties to the Derivative Action and the Delaware Action have announced that an agreement has been reached to settle the Delaware Action and the Derivative Action. Under the terms of the proposed settlement, which is subject to dismissal of related claims by the NY Federal Court, the 1995 Plan participants returned 4.5 million shares of Computer Associates stock to the Company. The Chancery Court in Delaware has approved the settlement and the parties are awaiting dismissal by the NY Federal Court. In the first quarter of fiscal year 2001, the Company recorded a $184 million gain in conjunction with the settlement.


On September 28, 2001, the United States Department of Justice filed a lawsuit alleging that the Company and PLATINUM technology International, inc. ("PLATINUM") had violated Federal antitrust laws, including alleged violation of the waiting period under the Hart-Scott-Rodino Act, in connection with the Company's acquisition of PLATINUM in May 1999. Although the ultimate outcome cannot be determined, management, after consultation and review with counsel, believes that the facts do not support the claims and that the Company and PLATINUM have meritorious defenses.


The Company, various subsidiaries and certain current and former officers have been named as defendants in other various claims and lawsuits arising in the normal course of business. The Company believes that it has meritorious defenses in connection with such claims and lawsuits and intends to vigorously contest each of them. In the opinion of the Company's management, the results of these other claims and lawsuits, either individually or in the aggregate, are not expected to have a material effect on the Company's results of operations, financial position or cash flows.

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Item 4: Submission of Matters to a Vote of Security Holders

(a)

Annual meeting of Stockholders held on August 29, 2001.
               

(b)

The Stockholders elected the following Directors for the ensuing year:

  
               
 

Russell M. Artzt

            
 

Linus W. L. Cheung

            
 

Alfonse M. D'Amato

            
 

Willem F.P. de Vogel

            
 

Richard A. Grasso

            
 

Shirley Strum Kenny

            
 

Sanjay Kumar

            
 

Roel Pieper

            
 

Lewis S. Ranieri

            
 

Charles B. Wang

            
               
               

(c) (i)

A separate tabulation with respect to each nominee for office is as follows:

  
               
     

Affirmative

  

Authority

    
 

Name                              

  

     Votes      

  

 Withheld 

    
 

Russell M. Artzt

  

347,630,980

  

 6,394,123

    
 

Linus W. L. Cheung

  

347,695,608

  

 6,329,495

    
 

Alfonse M. D'Amato

  

347,442,852

  

 6,581,650

    
 

Willem F.P. de Vogel

  

347,678,681

  

 6,342,902

    
 

Richard A. Grasso

  

347,714,853

  

 6,306,730

    
 

Shirley Strum Kenny

  

347,669,263

  

 6,355,840

    
 

Sanjay Kumar

  

347,592,344

  

 6,432,759

    
 

Roel Pieper

  

347,714,767

  

 6,310,336

    
 

Lewis S. Ranieri

  

347,685,131

  

 6,339,972

    
 

Charles B. Wang

  

331,496,936

  

22,528,167 

    
 

Richard J. Agnich

  

107,014,543

  

 1,011,157

    
 

Stephen R. Perkins

  

107,011,342

  

 1,011,339

    
 

Cece Smith

  

107,025,452

  

 1,000,348

    
 

Elizabeth Ann VanStory

  

107,034,031

  

    988,149

    
               
               

(c) (ii)

The Stockholders voted to approve the 2001 Stock Option Plan as follows:
               
 

Affirmative Votes

  

418,203,716

        
 

Negative Votes

  

32,760,177

        
 

Abstentions

  

11,083,355

        
               
               

(c) (iii)

The Stockholders voted to ratify the appointment of KPMG LLP as the Company's independent auditors for the fiscal year ending March 31, 2002 as follows:
               
 

Affirmative Votes

  

448,761,290

        
 

Negative Votes

  

3,395,333

        
 

Abstentions

  

9,890,640

        

21

 

 

Item 6: Exhibits and Reports on Form 8-K

(a) Exhibits:

None

(b) Reports on Form 8-K:

None

 

 

 

 

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.

 

COMPUTER ASSOCIATES INTERNATIONAL, INC.

Dated: November 7, 2001

By:

/s/ Sanjay Kumar                                            
   

Sanjay Kumar, President
   

and Chief Executive Officer
     
     

Dated: November 7, 2001

By:

/s/ Ira Zar                                                        
   

Ira Zar, Executive Vice President and
   

Principal Financial and Accounting Officer
     

 

22