[May 09, 2013] CA, INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations. Tweet (Edgar Glimpses Via Acquire Media NewsEdge) Introduction This "Management's Discussion and Analysis of Financial Condition and Results of Operations" (MD&A) is intended to provide an understanding of our financial condition, changes in financial condition, cash flow, liquidity and results of operations. This MD&A should be read in conjunction with our Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K and the Risk Factors included in Part I, Item 1A of this Form 10-K, as well as other cautionary statements and risks described elsewhere in this Form 10-K. Business Overview We are a leading provider of enterprise information technology (IT) management software and solutions. We help customers maximize their existing technology investments and recognize the potential of new technology to drive innovation. We transform IT to simplify complexity, free up resources and focus on service quality. We also secure IT to reduce the risk of improper access and fraud. We do this across our customers' choices of platforms - from mainframe and distributed to virtual, cloud and mobile, and across technologies and vendors. 22-------------------------------------------------------------------------------- Table of Contents We deliver solutions across the complete service lifecycle, which ranges from portfolio planning and service modeling in pre-production to service assembly, automation, assurance and management in production. This specialized customer-centric and practical approach helps customers manage and maintain IT systems and deliver new, innovative services with speed and agility, while bridging the gap between what businesses want to compete more effectively and what IT can deliver. Organizations are looking to IT to gain a competitive edge through faster delivery of products, services and applications, new customer acquisition, and agile responses to market change. To achieve these desired business outcomes, many organizations are improving the efficiency and availability of their IT resources and applications by: adopting server virtualization and cloud computing; delivering an experience that embraces social media and the proliferation of smart devices; leveraging application development and IT operations to speed application release cycles; and looking at the flexibility inherent in the variety of Software-as-a-Service (SaaS) offerings available in the market. While these technologies and new business models can reduce operating costs tied to physical infrastructure and increase agility, they also push IT into more complex and hybrid computing environments comprising mainframes, physical servers, virtualized servers and private, public and hybrid (a combination of public and private) cloud environments. To address these challenges, we believe it is vital for companies to effectively accelerate IT innovation and transform and secure all of their various computing environments, while being able to deliver new services quickly based on their business needs. Our core strengths in IT management and security, combined with our investments in innovative technologies, position us to serve a wide range of customers. We have a broad and deep portfolio of software solutions to address customer needs across computing platforms, from mainframe and distributed to virtual, cloud and mobile, and across the service lifecycle. We deliver these solutions on-premises and are continuing to transition many of our products to a SaaS delivery model. We organize our offerings into our Mainframe Solutions, Enterprise Solutions and Services operating segments. In the beginning of fiscal 2013, we divided our customers into three groups: (1) approximately 1,000 core large existing enterprise customers with annual revenue in excess of $2 billion (Large Existing Enterprises), which accounted for approximately 80% of our revenue; (2) enterprises with revenue in excess of $2 billion that were not historically significant customers of ours (Large New Enterprises), a customer segment that included an estimated 4,500 potential new customers, but where we focused on approximately only 1,000 of these customers selected based on our geographical and vertical strengths; and (3) more than 7,000 enterprises with revenue between $300 million and $2 billion and in fast growing geographies like Latin America and Asia (Growth Markets). At the beginning of fiscal 2014 we further refined our approach, combining our Large New Enterprises and Growth Markets go-to-market efforts into a single sales coverage model to better capture these opportunities. All these efforts are designed to accelerate new product sales outside of our contract renewal cycle. At the same time, we continue to dedicate sales resources and deploy additional solutions to address opportunities to sell to new customers. We believe we can grow our business and increase market share by delivering differentiated technology and working through partners. Market segmentation allows us to better align marketing and go-to-market initiatives with how customers want to buy. We have also implemented broad-based business initiatives to drive accountability for execution. We believe that these initiatives will benefit our performance in the long-term. CA Technologies Business Model We generate revenue from the following sources: license fees - licensing our products on a right-to-use basis; maintenance fees -providing customer technical support and product enhancements; and service fees - providing professional services such as product implementation, consulting and education. The timing and amount of fees recognized as revenue during a reporting period are determined in accordance with generally accepted accounting principles in the United States of America (GAAP). Revenue is reported net of applicable sales taxes. Under our business model, we offer customers a wide range of licensing options. For traditional, on-premises licensing, we typically license to customers either perpetually or on a subscription basis for a specified term. Our customers also purchase maintenance and support services that provide technical support and any general product enhancements released during the maintenance period. Under a perpetual license, the customer has the right to use the licensed program for an indefinite period of time upon payment of a one-time license fee. If the customer wants to receive maintenance, the customer is required to pay an additional annual maintenance fee. Under a subscription license, the customer has the right to usage and maintenance of the licensed products during the term of the agreement. Under our flexible licensing terms, customers can license our software products under multi-year licenses, with most customers choosing terms of one-to-five years, although longer terms may sometimes be negotiated by customers in order to obtain greater cost certainty. Thereafter, the license generally renews for the same period of time on the same terms and conditions, but subject to the customer's payment of our then prevailing subscription license fee. 23-------------------------------------------------------------------------------- Table of Contents For our mainframe solutions, the majority of our licenses provide customers with the right to use one or more of our products up to a specific license capacity, generally measured in millions of instructions per second (MIPS). For these products, customers may acquire additional capacity during the term of a license by paying us an additional license fee. For our enterprise solutions, our licenses may provide customers with the right to use one or more of our products limited to a number of servers, users or copies, among other things. Customers may license these products for additional servers, users or copies, etc., during the term of a license by paying us an additional license fee. SaaS is another delivery model we offer to our customers who prefer to utilize our technology off-premises with little to no infrastructure required. Our SaaS offerings are typically licensed using a subscription fee, most commonly on a monthly or annual basis. Our services are typically delivered on a time and materials basis, but alternative pay arrangements, such as fixed fee or staff augmentations, can also be arranged. Executive Summary The following is a summary of the analysis of our results contained in our MD&A. Total revenue for fiscal 2013 decreased 4% to $4,643 million compared with $4,814 million in fiscal 2012 primarily due to an unfavorable foreign exchange effect and a decrease in subscription and maintenance revenue. Subscription and maintenance revenue declined primarily due to lower new product and mainframe capacity sales in prior periods. For fiscal 2012, software fees and other revenue included $39 million in revenue under a license agreement we entered into in connection with a litigation settlement (refer to the "Software Fees and Other" section under Results of Operations for additional information). The unfavorable foreign exchange effect for fiscal 2013 was $95 million. Due to our sales performance during fiscal 2013 and the resulting decrease in our current revenue backlog, we expect a year-over-year decrease in total revenue for fiscal 2014 compared with fiscal 2013. Total bookings for fiscal 2013 decreased 12% to $4,114 million compared with $4,663 million in fiscal 2012 primarily as a result of a year-over-year decline in mainframe renewals, enterprise and mainframe new product sales and mainframe capacity sales reflected in subscription and maintenance bookings and to a lesser extent a decrease in professional services bookings. These decreases were slightly offset by an increase in software fees and other bookings that are or will be recognized as software fees and other revenue and were primarily driven by growth in our SaaS offerings. For fiscal 2012, software fees and other bookings included the $39 million from the license agreement we entered into in connection with a litigation settlement. Renewal bookings, which generally do not include new product and capacity sales and professional services arrangements, for fiscal 2013 declined by a high single digit percentage compared with fiscal 2012, which is slightly better than the expected decline of approximately 10%. For the fourth quarter of fiscal 2013, our percentage renewal yield was in the low 90% range. We currently expect the value of our fiscal 2014 renewals to increase by a percentage in the high single digits, excluding a large customer renewal that is expected to occur in the fourth quarter of fiscal 2014, compared with fiscal 2013. We expect a majority of the increase in renewals to occur in the second half of fiscal 2014. Total expense before interest and income taxes for fiscal 2013 decreased 4% to $3,281 million compared with $3,425 million in fiscal 2012. The decrease was primarily attributable to a decrease in selling and marketing expenses, a decrease in general and administrative expenses and a favorable foreign exchange effect on operating expenses for fiscal 2013. The decrease in operating expenses for fiscal 2013 compared with fiscal 2012 was also due to $35 million of income from an intellectual property transaction recognized in "Other (gains) expenses, net" in the first quarter of fiscal 2013. Partially offsetting these decreases was an increase in amortization of capitalized software costs, which includes an impairment of $55 million of our purchased software intangible assets. We currently expect the costs associated with our fiscal 2014 re-balancing actions to unfavorably affect operating expenses for fiscal 2014 (see Note 19, "Subsequent Events," in the Notes to the Consolidated Financial Statements for additional information). Income before interest and income taxes for fiscal 2013 decreased 2% to $1,362 million compared with $1,389 million in fiscal 2012, which reflects the overall decrease in revenue. Tax expense for fiscal 2013 decreased 13% to $363 million compared with $416 million in fiscal 2012, primarily as a result of a decrease in income before taxes, and from resolutions of uncertain tax positions relating to U.S and non-U.S. jurisdictions that are not expected to recur. The positive resolution of a tax audit subsequent to the end of fiscal 2013 is expected to favorably affect tax expense for fiscal 2014 (see Note 19, "Subsequent Events," in the Notes to the Consolidated Financial Statements for additional information). Diluted income per common share from continuing operations for fiscal 2013 was $2.07 compared with $1.90 in fiscal 2012, primarily reflecting an increase in income from continuing operations, our repurchases of common shares and a decrease in our fiscal 2013 effective tax rate. 24-------------------------------------------------------------------------------- Table of Contents For fiscal 2013, our segment results were as follows: For fiscal 2013, Mainframe Solutions revenue decreased from the year ago period by $123 million, or 5%. The reduction was driven primarily by an unfavorable foreign exchange effect of $56 million, $39 million in revenue received in the third quarter of fiscal 2012 under a license agreement we entered into in connection with a litigation settlement (see the "Software Fees and Other" section under Results of Operations for additional information), and a decrease in new product and capacity sales in prior periods. The increase in Mainframe Solutions operating margin for fiscal 2013 was primarily a result of the decrease in selling and marketing expenses, a favorable effect of foreign exchange on operating expenses, a decrease in general and administrative expenses and a decrease in severance costs. For fiscal 2013, Enterprise Solutions revenue decreased from the year ago period by $48 million, or 3%, primarily due to an unfavorable foreign exchange effect of $32 million and lower new product sales from prior periods. Within Enterprise Solutions revenue, there was a decrease in revenue from our service assurance, automation and data management products, partially offset by an increase in revenue attributable to our ITKO and Nimsoft products. Enterprise Solutions operating margin for fiscal 2013 increased by one percentage point from 8 percent to 9 percent as a result of the income from a $35 million intellectual property transaction in the first quarter of fiscal 2013 (see "Other gains, net" under Results of Operations for additional information), which contributed two percentage points to Enterprise Solutions operating margin in fiscal 2013, as well as a decrease in severance costs compared with fiscal 2012. These favorable items were offset by our additional investments in ITKO and Nimsoft products. For fiscal 2013, Services revenue and expenses compared with fiscal 2012 remained consistent. Services operating margin was 6% for fiscal 2013 and fiscal 2012. Total revenue backlog for fiscal 2013 decreased 8% to $7,774 million compared with $8,473 million in fiscal 2012. The decrease was primarily due to the decline of total bookings in fiscal 2013 and prior periods and the increase in the percentage of bookings recognized as up-front revenue in software fees and other revenue in fiscal 2013, which is not included in revenue backlog. The current portion of revenue backlog for fiscal 2013 decreased 4% to $3,563 million compared with $3,714 million in fiscal 2012. Excluding the effect of foreign exchange, the current portion of revenue backlog decreased 3%. Based on fiscal 2013 performance and our expectation that our renewal portfolio for fiscal 2014 will be back-end loaded, we expect a continued decline in current revenue backlog into the second half of fiscal 2014. Generally, we believe that a change in the current portion of revenue backlog on a year-over-year basis is an indicator of future subscription and maintenance revenue performance due to the high percentage of our revenue that is recognized from license agreements that are already committed and being recognized ratably. Cash provided by operating activities-continuing operations for fiscal 2013 decreased 6% to $1,408 million compared with $1,505 million in fiscal 2012. The decrease was primarily due to the decrease in cash collections from billings of $285 million, partially offset by the decrease in vendor disbursements, payroll and other disbursements, net of $101 million and the decrease in income tax payments of $87 million. For fiscal 2013, there was an increase in single installment payments of $193 million. Product development and enhancements expenses are expected to increase in future periods as the amount capitalized for internally developed software costs decreases (see "Amortization of Capitalized Software Costs" under Results of Operations for additional information). This will result in additional operating cash outflows relating to development expenses for fiscal 2014. In addition, we currently expect the payments associated with our fiscal 2014 re-balancing actions (see Note 19, "Subsequent Events," in the Notes to the Consolidated Financial Statements for additional information) and an increase in cash taxes to have unfavorable effects on cash flows from operations for fiscal 2014. As a result, we expect a year-over-year decrease in cash flows from operations for fiscal 2014 compared with fiscal 2013. 25-------------------------------------------------------------------------------- Table of Contents Performance Indicators Management uses several quantitative and qualitative performance indicators to assess our financial results and condition. Each provides a measurement of the performance of our business and how well we are executing our plan. Our predominantly subscription-based business model is less common among our competitors in the software industry and it may be difficult to compare the results for many of our performance indicators with those of our competitors. The following is a summary of the principal performance indicators that management uses to review performance: Year Ended March 31, Percent 2013 2012 Change Change (dollars in millions) Total revenue $ 4,643 $ 4,814 $ (171 ) (4 )% Income from continuing operations $ 955 $ 938 $ 17 2 % Cash provided by operating activities - continuing operations $ 1,408 $ 1,505 $ (97 ) (6 )% Total bookings $ 4,114 $ 4,663 $ (549 ) (12 )% Subscription and maintenance bookings $ 3,238 $ 3,776 $ (538 ) (14 )% Weighted average subscription and maintenance license agreement duration in years 3.27 3.46 (0.19 ) (5 )% At March 31, Percent 2013 2012 Change Change (dollars in millions) Cash, cash equivalents and short-term investments(1) $ 2,776 $ 2,679 $ 97 4 % Total debt $ 1,290 $ 1,301 $ (11 ) (1 )% Total expected future cash collections from committed contracts(2) $ 5,173 $ 5,745 $ (572 ) (10 )% Total revenue backlog(2) $ 7,774 $ 8,473 $ (699 ) (8 )% Total current revenue backlog(2) $ 3,563 $ 3,714 $ (151 ) (4 )% (1) At March 31, 2013, short-term investments were $183 million. At March 31, 2012, short-term investments were less than $1 million. (2) Refer to the discussion in the "Liquidity and Capital Resources" section of this MD&A for additional information about expected future cash collections from committed contracts, billing backlog and revenue backlog. Analyses of our performance indicators shown above and our segment performance can be found in the "Results of Operations" and "Liquidity and Capital Resources" sections of this MD&A. Total Revenue - Total revenue is the amount of revenue recognized during the reporting period from the sale of license, maintenance and professional services agreements. Amounts recognized as subscription and maintenance revenue are recognized ratably over the term of the agreement. Professional services revenue is generally recognized as the services are performed or recognized on a ratable basis over the term of the related software license. Software fees and other revenue generally represents license fee revenue recognized at the inception of a license agreement (up-front basis) and also includes our SaaS revenue, which is recognized as services are provided. Total Bookings - Total bookings, or sales, includes the incremental value of all subscription, maintenance and professional services contracts and software fees and other contracts entered into during the reporting period and is generally reflective of the amount of products and services during the period that our customers have agreed to purchase from us. Revenue for bookings attributed to sales of software products for which license fee revenue is recognized on an up-front basis is reflected in "Software fees and other" in our Consolidated Statements of Operations. As our business strategy has evolved, our management looks within bookings at total new product and capacity sales, which we define as sales of products or mainframe capacity that are new or in addition to products or mainframe capacity previously contracted for by a customer. The amount of new product and capacity sales for a period, as currently tracked by us, requires estimation by management and has not been historically reported. Within a given period, the amount of new product and capacity sales may not be material to the change in our total bookings or revenue compared with prior periods. New product and capacity sales can be reflected as subscription and maintenance bookings in the period (for which revenue would be recognized ratably over the term of the contract) or in software fees and other bookings (which are recognized as software fees and other revenue in the current period). 26-------------------------------------------------------------------------------- Table of Contents Subscription and Maintenance Bookings -Subscription and maintenance bookings is the aggregate incremental amount we expect to collect from our customers over the terms of the underlying subscription and maintenance agreements entered into during a reporting period. These amounts include the sale of products directly by us and may include additional products, services or other fees for which we have not established vendor specific objective evidence (VSOE). Subscription and maintenance bookings also includes indirect sales by distributors and volume partners, value-added resellers and exclusive representatives to end-users, where the contracts incorporate the right for end-users to receive unspecified future software products, and other contracts without these rights entered into in close proximity or contemplation of such agreements. These amounts are expected to be recognized ratably as subscription and maintenance revenue over the applicable term of the agreements. Subscription and maintenance bookings exclude the value associated with certain perpetual licenses, license-only indirect sales, SaaS offerings and professional services arrangements. The license and maintenance agreements that contribute to subscription and maintenance bookings represent binding payment commitments by customers over periods that range generally from three to five years, although in certain cases customer commitments can be for longer or shorter periods. These current period bookings are often renewals of prior contracts that also had various durations, usually from three to five years. The amount of new subscription and maintenance bookings recorded in a period is affected by the volume, duration and value of contracts renewed during that period. Subscription and maintenance bookings typically increases in each consecutive quarter during a fiscal year, with the first quarter having the least bookings and the fourth quarter having the most bookings. However, subscription and maintenance bookings may not always follow the pattern of increasing in consecutive quarters during a fiscal year, and the quarter-to-quarter differences in subscription and maintenance bookings may vary. Given the varying durations of the contracts being renewed, year-over-year comparisons of bookings are not always indicative of the overall bookings trend. Within bookings, we also consider the yield on our renewals. We define "renewal yield" as the percentage of the renewable value of a prior contract (i.e., the maintenance value and, in the case of non-perpetual licenses, the license value) realized in current period bookings. The renewable value of a prior contract is an estimate affected by various factors including contractual renewal terms, price increases and other conditions. We estimate the aggregate yield for a quarter based on a review of material transactions representing a substantial majority of the dollar value of renewals during the current period. There may be no correlation between year-over-year changes in bookings and year-over-year changes in renewal yield, since renewal yield is based on the renewable value of contracts of various durations, most of which are longer than one year. Additionally, period-to-period changes in subscription and maintenance bookings do not necessarily correlate to changes in cash receipts. The contribution to current period revenue from subscription and maintenance bookings from any single license or maintenance agreement is relatively small, since revenue is recognized ratably over the applicable term for these agreements. Weighted Average Subscription and Maintenance License Agreement Duration in Years - The weighted average subscription and maintenance license agreement duration in years reflects the duration of all subscription and maintenance agreements executed during a period, weighted by the total contract value of each individual agreement. Weighted average subscription and maintenance license agreement duration in years can fluctuate from period to period depending on the mix of license agreements entered into during a period. Weighted average duration information is disclosed in order to provide additional understanding of the volume of our bookings. Total Revenue Backlog - Total revenue backlog represents the aggregate amount we expect to recognize as revenue in the future as either subscription and maintenance revenue, professional services revenue or software fees and other revenue associated with contractually committed amounts billed or to be billed as of the balance sheet date. Total revenue backlog is composed of amounts recognized as liabilities in our Consolidated Balance Sheets as deferred revenue (billed or collected) as well as unearned amounts yet to be billed under subscription and maintenance and software fees and other agreements. Classification of amounts as current and noncurrent depends on when such amounts are expected to be earned and therefore recognized as revenue. Amounts that are expected to be earned and therefore recognized as revenue in 12 months or less are classified as current, while amounts expected to be earned in greater than 12 months are classified as noncurrent. The portion of the total revenue backlog that relates to subscription and maintenance agreements is recognized as revenue evenly on a monthly basis over the duration of the underlying agreements and is reported as subscription and maintenance revenue in our Consolidated Statements of Operations. Generally, we believe that an increase or decrease in the current portion of revenue backlog on a year-over-year basis is a favorable or unfavorable indicator of future subscription and maintenance revenue performance, respectively, due to the high percentage of our revenue that is recognized from license agreements that are already committed and being recognized ratably. "Deferred revenue (billed or collected)" is composed of: (i) amounts received from customers in advance of revenue recognition and (ii) amounts billed but not collected for which revenue has not yet been earned. 27-------------------------------------------------------------------------------- Table of Contents Results of Operations The following table presents revenue and expense line items reported in our Consolidated Statements of Operations for fiscal 2013, 2012 and 2011 and the period-over-period dollar and percentage changes for those line items. Year Ended March 31, Dollar Change Percent Change Dollar Change Percent Change 2013 2012 2011 2013/2012 2013/2012 2012/2011 2012/2011 (dollars in millions) Revenue: Subscription and maintenance revenue $ 3,858 $ 4,021 $ 3,822 $ (163 ) (4 )% $ 199 5 % Professional services 382 382 327 - - % 55 17 % Software fees and other 403 411 280 (8 ) (2 )% 131 47 % Total revenue $ 4,643 $ 4,814 $ 4,429 $ (171 ) (4 )% $ 385 9 % Expenses: Costs of licensing and maintenance $ 284 $ 286 $ 278 $ (2 ) (1 )% $ 8 3 % Cost of professional services 354 357 303 (3 ) (1 )% 54 18 % Amortization of capitalized software costs 319 225 192 94 42 % 33 17 % Selling and marketing 1,276 1,394 1,286 (118 ) (8 )% 108 8 % General and administrative 405 462 451 (57 ) (12 )% 11 2 % Product development and enhancements 490 510 471 (20 ) (4 )% 39 8 % Depreciation and amortization of other intangible assets 158 176 187 (18 ) (10 )% (11 ) (6 )% Other (gains) expenses, net (5 ) 15 7 (20 ) (133 )% 8 114 % Total expense before interest and income taxes $ 3,281 $ 3,425 $ 3,175 $ (144 ) (4 )% $ 250 8 % Income before interest and income taxes $ 1,362 $ 1,389 $ 1,254 $ (27 ) (2 )% $ 135 11 % Interest expense, net 44 35 45 9 26 % (10 ) (22 )% Income before income taxes $ 1,318 $ 1,354 $ 1,209 $ (36 ) (3 )% $ 145 12 % Income tax expense 363 416 386 (53 ) (13 )% 30 8 % Income from continuing operations $ 955 $ 938 $ 823 $ 17 2 % $ 115 14 % 28-------------------------------------------------------------------------------- Table of Contents The following table sets forth, for the fiscal years indicated, the percentage of total revenue presented by the items in the accompanying Consolidated Statements of Operations. Percentage of Total Revenue for the Year Ended March 31, 2013 2012 2011 Revenue: Subscription and maintenance revenue 83 % 84 % 86 % Professional services 8 8 7 Software fees and other 9 8 7 Total revenue 100 % 100 % 100 % Expenses: Costs of licensing and maintenance 6 % 6 % 6 % Cost of professional services 8 7 7 Amortization of capitalized software costs 7 5 4 Selling and marketing 27 29 29 General and administrative 9 10 10 Product development and enhancements 11 11 11 Depreciation and amortization of other intangible assets 3 4 4 Other (gains) expenses, net - - - Total expenses before interest and income taxes 71 % 71 % 72 % Income before interest and income taxes 29 % 29 % 28 % Interest expense, net 1 1 1 Income before income taxes 28 % 28 % 27 % Income tax expense 8 9 9 Income from continuing operations 21 % 19 % 19 % Note: Amounts may not add to their respective totals due to rounding. Revenue As more fully described below, total revenue decreased in fiscal 2013 compared with fiscal 2012 and increased in fiscal 2012 compared with fiscal 2011. During fiscal 2013, total revenue reflected an unfavorable foreign exchange effect of $95 million compared with fiscal 2012 and a decrease in subscription and maintenance revenue. During fiscal 2012, total revenue reflected a favorable foreign exchange effect of $89 million compared with fiscal 2011. Due to our sales performance during fiscal 2013 and the resulting decrease in our current revenue backlog, we expect a year-over-year decrease in total revenue for fiscal 2014 compared with fiscal 2013. Subscription and Maintenance Revenue Subscription and maintenance revenue is the amount of revenue recognized ratably during the reporting period from: (i) subscription license agreements that were in effect during the period, generally including maintenance that is bundled with and not separately identifiable from software usage fees or product sales, (ii) maintenance agreements associated with providing customer technical support and access to software fixes and upgrades that are separately identifiable from software usage fees or product sales, and (iii) license agreements bundled with additional products, maintenance or professional services for which VSOE has not been established. These amounts include the sale of products directly by us, as well as by distributors and volume partners, value-added resellers and exclusive representatives to end-users, where the contracts incorporate the right for end-users to receive unspecified future software products, and other contracts entered into in close proximity or contemplation of such agreements. The decrease in subscription and maintenance revenue for fiscal 2013 compared with fiscal 2012 was primarily attributable to an unfavorable foreign exchange effect of $82 million. The decrease in subscription and maintenance revenue was also attributable to a decrease in both current and prior fiscal years' new product and mainframe capacity sales. In addition, the increased percentage of bookings recognized as software fees and other revenue during fiscal 2013 had an unfavorable effect on subscription and maintenance revenue. If the percentage of these bookings increases in the future, this will continue to have an unfavorable effect on subscription and maintenance revenue. 29-------------------------------------------------------------------------------- Table of Contents The increase in subscription and maintenance revenue for fiscal 2012 compared with fiscal 2011 was primarily due to revenue associated with a five-year license agreement with a large IT outsourcer for approximately $500 million that was executed in the fourth quarter of fiscal 2011. In addition, for fiscal 2012, there was a favorable foreign exchange effect of $79 million compared with fiscal 2011. Professional Services Professional services revenue primarily includes product implementation, consulting, customer training and customer education. Professional services revenue for fiscal 2013 was consistent with fiscal 2012. Professional services revenue increased in fiscal 2012 compared with fiscal 2011, primarily due to our fiscal 2012 acquisition of Base Technologies. Software Fees and Other Software fees and other revenue primarily consists of revenue that is recognized on an up-front basis. This includes revenue associated with enterprise solutions products sold on an up-front basis directly by our sales force or through transactions with distributors and volume partners, value-added resellers and exclusive representatives (sometimes referred to as our "indirect" or "channel" revenue). It also includes our SaaS revenue, which is recognized as the services are provided, generally ratably over the term of the SaaS arrangement, rather than up-front. During the third quarter of fiscal 2012, we recognized $39 million in revenue under a license agreement we entered into in connection with a litigation settlement with Rocket Software, Inc. (Rocket) during fiscal 2009 that resolved our claims against Rocket for copyright infringement and trade secret misappropriation. Rocket did not admit any wrongdoing in connection with this settlement. As part of this settlement, Rocket agreed to license technology from us, including source code authored several years ago and related trade secrets that were the subject of the litigation. The amount received during the third quarter of fiscal 2012 reflects the final amount owed to us, which was not scheduled to be paid in full until fiscal 2014 (the Final License Payment). Rocket paid this amount in advance at their discretion, unsolicited by us and without any discount or concession by us. Software fees and other revenue decreased for fiscal 2013 compared with fiscal 2012 due to the Final License Payment recognized in the third quarter of fiscal 2012, partially offset by an increase of $24 million in revenue from our SaaS offerings and an increase of $6 million in revenue from our perpetual enterprise solutions products. In fiscal 2012, there was a year-over-year increase in sales associated with our perpetual enterprise solutions products of $65 million, of which $31 million was for products that were newly eligible for up-front revenue recognition in the second half of fiscal 2012 and $13 million was associated with our acquisition of ITKO. In addition, the increase was also attributable to the aforementioned Final License Payment and an increase of $34 million in revenue from our SaaS offerings. Total Revenue by Geography The following table presents the amount of revenue earned from sales to unaffiliated customers in the United States and international regions and corresponding percentage changes for fiscal 2013, 2012 and 2011. Fiscal 2013 Fiscal 2012 Compared With Compared With Fiscal 2012 Fiscal 2011 (dollars in millions) % % 2013 % Of Total 2012 % Of Total Change 2012 % Of Total 2011 % Of Total Change United States $ 2,747 59 % $ 2,812 58 % (2 )% $ 2,812 58 % $ 2,519 57 % 12 % International 1,896 41 % 2,002 42 % (5 )% 2,002 42 % 1,910 43 % 5 % Total $ 4,643 100 % $ 4,814 100 % (4 )% $ 4,814 100 % $ 4,429 100 % 9 % Revenue in the United States decreased by $65 million, or 2%, for fiscal 2013 compared with fiscal 2012 primarily due to a decrease in subscription and maintenance revenue, as described above. International revenue decreased by $106 million, or 5%, for fiscal 2013 compared with fiscal 2012, primarily due to an unfavorable foreign exchange effect of $95 million. Excluding the unfavorable foreign exchange effect, revenue was down in all regions except the Latin America region. Revenue in the United States increased by $293 million, or 12%, for fiscal 2012 compared with fiscal 2011 primarily due to higher subscription and maintenance revenue and software fees and other revenue. International revenue increased by $92 million, or 5%, for fiscal 2012 compared with fiscal 2011 primarily due to a favorable foreign exchange effect of $89 million. Excluding the favorable foreign exchange effect, international revenue would have increased by $3 million primarily as a result of revenue growth in Latin America and the Asia-Pacific region, which was offset by lower revenue in Europe, Middle East and Africa. 30-------------------------------------------------------------------------------- Table of Contents Price changes do not have a material effect on revenue in the period in which they are implemented as a result of our ratable subscription model. Expenses Operating expenses for fiscal 2013 decreased compared with fiscal 2012 due to a decrease in selling and marketing expenses, a decrease in general and administrative expenses, a favorable effect of foreign exchange on operating expenses, a decrease in severance costs and a decrease of $20 million due to a change in our employee vacation benefits. In addition, there was $35 million of income from an intellectual property transaction recognized in "Other (gains) expenses, net" in the first quarter of fiscal 2013. Partially offsetting these decreases was an increase in amortization of capitalized software costs. We currently expect the costs associated with our fiscal 2014 re-balancing actions to unfavorably affect operating expenses for fiscal 2014 (see Note 19, "Subsequent Events," in the Notes to the Consolidated Financial Statements for additional information). The overall increase in operating expenses for fiscal 2012 compared with fiscal 2011 was primarily due an increase in costs associated with acquisitions, an increase in personnel-related costs for selling and marketing and an increase in expenses for product development and enhancements. Costs of Licensing and Maintenance Costs of licensing and maintenance include technical support, royalties, and other manufacturing and distribution costs. Costs of licensing and maintenance for fiscal 2013 were consistent with fiscal 2012. The increase in costs of licensing and maintenance for fiscal 2012 compared with fiscal 2011 was due to an increase in costs associated with acquisitions. Cost of Professional Services Cost of professional services consists primarily of our personnel-related costs associated with providing professional services and training to customers. Cost of professional services for fiscal 2013 was consistent with fiscal 2012 and operating margin for professional services was 7% for each of fiscal 2013 and fiscal 2012. For fiscal 2012 compared with fiscal 2011, cost of professional services increased primarily as a result of our fiscal 2012 acquisition of Base Technologies. Operating margin for professional services was 7% for each of fiscal 2012 and 2011. Operating margin for professional services does not include certain additional costs that are allocated to the Services segment (see "Performance of Segments" below). Amortization of Capitalized Software Costs Amortization of capitalized software costs consists of the amortization of both purchased software and internally generated capitalized software development costs. Internally generated capitalized software development costs relate to new products and significant enhancements to existing software products that have reached the technological feasibility stage. The increase in amortization of capitalized software costs for fiscal 2013 compared with fiscal 2012 was due to an impairment recorded in the fourth quarter of fiscal 2013 of $55 million relating to purchased software (see Note 6, "Long Lived Assets," in the Notes to the Consolidated Financial Statements for additional information), as well as an increase in software development projects that have reached general availability in recent periods and amortization from assets acquired from our fiscal 2012 acquisitions. We evaluate the useful lives and recoverability of capitalized software and other intangible assets when events or changes in circumstances indicate that an impairment may exist. These evaluations require complex assumptions about key factors such as future customer demand, technology trends and the impact of those factors on the technology we acquire and develop for our products. Impairments or revisions to useful lives could result from the use of alternative assumptions that reflect reasonably possible outcomes related to future customer demand or technology trends for assets within the Enterprise Solutions segment. For fiscal 2012, amortization of capitalized software costs increased compared with fiscal 2011, primarily due to the increase in projects that reached general availability and amortization associated with technology acquired from our acquisitions. We expect that our product offerings and go-to-market strategy will be evolving in future periods to include solutions and product suites that may be delivered either on-premises or via SaaS or cloud platforms and that these product offerings will become available to customers at more frequent intervals than our historical release cycles. We also expect a more extensive adoption of agile development methodologies, which are characterized by a more dynamic development process with more frequent revisions to a product release's features and functions as the software is being developed. We expect that these factors will result in us commencing capitalization much later in the development life cycle. As a result, product development and enhancements expenses are expected to increase in future periods as the amount capitalized for internally developed software costs decreases. While this would ultimately result in lower future amortization expense for these assets, we do not expect a material effect in fiscal 2014. 31-------------------------------------------------------------------------------- Table of Contents Selling and Marketing Selling and marketing expenses include the costs relating to our sales force, channel partners, corporate and business marketing and customer training programs. For fiscal 2013, the decrease in selling and marketing expenses compared with fiscal 2012 was attributable to a decrease in personnel-related costs of $42 million, a favorable foreign exchange effect of $24 million, a decrease in commission expense of $22 million, a decrease in severance costs of $17 million, and a decrease in promotion expense of $17 million. The decrease in the personnel-related and promotion expenses was primarily attributable to our cost containment efforts. For fiscal 2012, the increase in selling and marketing expenses compared with fiscal 2011 was attributable to an increase in personnel-related costs of $63 million, an increase in severance costs of $22 million associated with our fiscal 2012 workforce reduction plan, an increase of $16 million associated with acquisitions, an unfavorable foreign exchange effect of $13 million and an increase in commission expenses of $12 million. These increases were partially offset by a $28 million decrease in promotional and travel costs for fiscal 2012 compared with fiscal 2011. General and Administrative General and administrative expenses include the costs of corporate and support functions, including our executive leadership and administration groups, finance, legal, human resources, corporate communications and other costs such as provisions for doubtful accounts. For fiscal 2013, general and administrative expenses decreased compared with fiscal 2012, primarily due to a decrease in costs associated with external consultants of $24 million, a favorable foreign exchange effect of $10 million and a decrease in severance costs of $8 million. The decrease in external consultants expenses was primarily attributable to our cost containment efforts. For fiscal 2012, general and administrative expenses increased compared with fiscal 2011, primarily due to $14 million of costs associated with acquisitions and $9 million of severance costs in fiscal 2012. These increases were partially offset by a decrease in external consulting and personnel-related costs. Product Development and Enhancements For fiscal 2013 and fiscal 2012, product development and enhancements expenses represented 11% of total revenue. The slight decrease in product development and enhancements expenses for fiscal 2013 compared with fiscal 2012 was primarily attributable to a decrease in personnel-related costs. These decreases were partially offset by a decrease in the proportion of expenditures that were capitalized during fiscal 2013 compared with fiscal 2012. For fiscal 2012 and fiscal 2011, product development and enhancements expenses represented 11% of total revenue. The slight increase in product development and enhancements expenses for fiscal 2012 compared with fiscal 2011 was primarily due to additional costs incurred to broaden our enterprise solutions product offerings and $8 million of severance costs in fiscal 2012. Product development and enhancements expenses are expected to increase in future periods as the amount of capitalized software development costs decreases (see "Amortization of Capitalized Software Costs" above). Depreciation and Amortization of Other Intangible Assets The decrease in depreciation and amortization of other intangible assets for fiscal 2013 compared with fiscal 2012 was primarily due to the decrease in the amount of intangible assets acquired that are subject to amortization as a result of intangible assets becoming fully amortized. The decrease in depreciation and amortization of other intangible assets for fiscal 2012 compared with fiscal 2011 was primarily due to decreased amortization costs of intangible assets relating to prior period acquisitions. Other (Gains) Expenses, Net Other (gains) expenses, net includes gains and losses attributable to divested assets, foreign currency exchange rate fluctuations, and other miscellaneous items. Foreign exchange derivative contracts are used to mitigate our operating risks and exposure to foreign currency exchange rates. Year Ended March 31, (in millions) 2013 2012 2011 Losses (gains) attributable to divesture of assets $ - $ 2 $ (11 ) Foreign currency losses, net 12 4 18 Expense attributable to litigation claims and settlements 18 9 - Other (gains), net (35 ) - - Total $ (5 ) $ 15 $ 7 32-------------------------------------------------------------------------------- Table of Contents For fiscal 2013, other (gains) expenses, net included a transaction in the first quarter of fiscal 2013 to assign the rights of certain of our intellectual property assets to a large technology company for $35 million as part of an effort to more fully utilize our intellectual property assets. We will continue to have the ability to use these intellectual property assets in current and future product offerings. Partially offsetting this income for fiscal 2013 were $18 million of expenses in connection with litigation claims and $12 million in losses from foreign exchange, primarily relating to our Latin America region. For fiscal 2012, other (gains) expenses, net included $7 million of losses from foreign currency exchange rate fluctuations, partially offset by $3 million of gains relating to our foreign exchange derivative contracts, which we use to mitigate our operating risks and exposure to foreign currency exchange rates. In addition, for fiscal 2012, other (gains) expenses, net included $9 million of expenses in connection with litigation claims. For fiscal 2011, other (gains) expenses, net included $14 million of losses relating to our foreign exchange derivative contracts, which were used to mitigate our operating risks and exposure to foreign currency exchange rates. These losses were offset by foreign currency transaction gains due to the weakening of the U.S. dollar against the currencies of other countries in which we conduct our operations. During fiscal 2011, we received $10 million in settlements of claims associated with previous stockholder derivative actions following the substitution of us as plaintiff in those actions. These settlements were offset by expenses in connection with other litigation claims. In addition, during fiscal 2011 we recorded a $10 million gain from the sale of our interest in an investment. Interest Expense, Net The increase in interest expense, net for fiscal 2013 compared with fiscal 2012 was primarily attributable to a decrease in interest income due to lower interest rates and lower cash balances in the current period. The decrease in interest expense, net for fiscal 2012 compared with fiscal 2011 was primarily due to the decrease in interest expense resulting from our overall decrease in debt. During the first quarter of fiscal 2012, we repaid $250 million of our revolving credit facility, which was due August 2012. Refer to the "Liquidity and Capital Resources" section of this MD&A and Note 8, "Debt," in the Notes to the Consolidated Financial Statements for additional information. Income Taxes Our effective tax rate was 28%, 31% and 32%, for fiscal 2013, 2012 and 2011, respectively. The reduction in the effective tax rate for fiscal 2013, compared with fiscal 2012, resulted primarily from resolutions of uncertain tax positions relating to U.S and non-U.S. jurisdictions (including the completion of the examination of our U.S. federal income tax returns for the tax years ended March 31, 2008, 2009 and 2010) and the retroactive reinstatement of the U.S. Research and Development Tax Credit in January 2013, partially offset by refinements of tax positions taken for prior periods. These items taken together resulted in a net benefit of $63 million for fiscal 2013 as we continue our efforts to improve our long-term tax profile. The reduction in the effective tax rate for fiscal 2012, compared with fiscal 2011, resulted primarily from the recognition of tax benefits related to an investment in a foreign subsidiary and a decrease in the valuation allowance from the recognition of state net operating loss carryforwards due to a change in forecasted state taxable income. These items taken together resulted in a net benefit of $36 million for fiscal 2012. The reduction in the effective tax rate for fiscal 2011, compared with fiscal 2010, resulted primarily from affirmative claims in the context of tax audits, resolutions of uncertain tax positions relating to non-U.S. jurisdictions and the retroactive reinstatement of the U.S. Research and Development Tax Credit in December 2010, partially offset by refinements of tax positions taken in prior periods. These items taken together resulted in a net benefit of $33 million for fiscal 2011. No provision has been made for U.S. federal income taxes on $2,220 million and $1,999 million at March 31, 2013 and 2012, respectively, of unremitted earnings of our foreign subsidiaries since we plan to permanently reinvest all such earnings outside the United States. It is not practicable to determine the amount of tax associated with such unremitted earnings. On May 7, 2013, the Company received final approval by the Joint Committee of Taxation on the U.S. Internal Revenue Service (IRS) examination of the Company's federal income tax returns for the tax years ended March 31, 2005, 2006 and 2007. As a result, we estimate we will record an income tax benefit of approximately $165 million to $185 million in fiscal 2014 (see Note 19, "Subsequent Events," in the Notes to the Consolidated Financial Statements for additional information). Refer to Note 15, "Income Taxes," in the Notes to the Consolidated Financial Statements for additional information. Discontinued Operations In the first quarter of fiscal 2012, we sold our Internet Security business for $14 million. In the first quarter of fiscal 2011, we sold our Information Governance business, consisting primarily of the CA Records Manager and CA Message Manager software offerings and related professional services, for $19 million. 33-------------------------------------------------------------------------------- Table of Contents The results of discontinued operations for fiscal 2012 and 2011 included revenue of $15 million and $83 million, respectively, and income from operations, net of taxes, of $13 million and $4 million, respectively. Refer to Note 3, "Divestitures," in the Notes to the Consolidated Financial Statements for additional information. Performance of Segments Our Mainframe Solutions and Enterprise Solutions segments comprise our software business organized by the nature of our software offerings and the platform on which the products operate. Our Mainframe Solutions segment products help customers and partners transform mainframe management, gain more value from existing technology and extend mainframe capabilities. Our Enterprise Solutions segment consists of various product offerings, including service assurance, security (identity and access management), service and portfolio management and application delivery. The Services segment comprises implementation, consulting, education, training and support services. These services include those directly related to our mainframe solutions and enterprise solutions. We regularly enter into a single arrangement with a customer that includes mainframe solutions, enterprise solutions and services. The amount of contract revenue assigned to segments is generally based on the manner in which the proposal is made to the customer. The software product revenue is assigned to the Mainframe Solutions and Enterprise Solutions segments based on either: (1) a list price allocation method (which allocates a discount in the total contract price to the individual products in proportion to the list price of the product); (2) allocations included within internal contract approval documents; or (3) the value for individual software products as stated in the customer contract. The price for the implementation, consulting, education and training services is separately stated in the contract and these amounts of contract revenue are assigned to the Services segment. The contract value assigned to each segment is then recognized in a manner consistent with the revenue recognition policies we apply to the customer contract for purposes of preparing our Consolidated Financial Statements. Segment expenses include costs that are controllable by segment managers (i.e., direct costs) and, in the case of the Mainframe Solutions and Enterprise Solutions segments, an allocation of shared and indirect costs (i.e., allocated costs). Segment-specific direct costs include a portion of selling and marketing costs, licensing and maintenance costs, product development costs, general and administrative costs and amortization of the cost of internally developed software. Allocated segment costs primarily include indirect selling and marketing costs and general and administrative costs that are not directly attributable to a specific segment. The basis for allocating shared and indirect costs between the Mainframe Solutions and Enterprise Solutions segments is dependent on the nature of the cost being allocated and is either in proportion to segment revenues or in proportion to the related direct cost category. Expenses for the Services segment consist only of direct costs and there are no allocated or indirect costs for the Services segment. Segment expenses do not include the following: share-based compensation expense; amortization of purchased software; amortization of other intangible assets; derivative hedging gains and losses; and other miscellaneous costs. Segment financial information for fiscal 2013, 2012 and 2011 is as follows: Mainframe Solutions Fiscal 2013 Fiscal 2012 Fiscal 2011 Revenue $ 2,489 $ 2,612 $ 2,479 Expenses 1,016 1,140 1,129 Segment profit $ 1,473 $ 1,472 $ 1,350 Segment operating margin 59 % 56 % 54 % For fiscal 2013, Mainframe Solutions revenue decreased by $123 million compared with fiscal 2012. The reduction was driven primarily by an unfavorable foreign exchange effect of $56 million, a $39 million Final License payment received in the third quarter of fiscal 2012, and lower mainframe new product and capacity sales in prior periods. Mainframe Solutions operating margin for fiscal 2013 was 59% compared with 56% for fiscal 2012. The increase in Mainframe Solutions operating margin for fiscal 2013 was primarily a result of the decrease in selling and marketing expenses, a favorable effect of foreign exchange on operating expenses, a decrease in general and administrative expenses and a decrease in severance costs. For fiscal 2012, Mainframe Solutions revenue increased by $133 million compared with fiscal 2011. The year-over-year increase in Mainframe Solutions revenue for fiscal 2012 was primarily attributable to $55 million from the five-year license agreement with a large IT outsourcer executed in the fourth quarter of fiscal 2011, a favorable foreign exchange effect of $53 million and $39 million from the aforementioned Final License Payment. Mainframe Solutions operating margin for fiscal 2012 was 56% compared with 54% for fiscal 2011. The increase in Mainframe Solutions operating margin for fiscal 2012 was primarily due to the increase in revenue, partially offset by severance costs of $22 million in fiscal 2012. 34-------------------------------------------------------------------------------- Table of Contents Enterprise Solutions Fiscal 2013 Fiscal 2012 Fiscal 2011 Revenue $ 1,772 $ 1,820 $ 1,623 Expenses 1,612 1,668 1,501 Segment profit $ 160 $ 152 $ 122 Segment operating margin 9 % 8 % 8 % Enterprise Solutions revenue for fiscal 2013 decreased by $48 million compared with the year-ago period primarily due to an unfavorable foreign exchange effect of $32 million and lower new product sales from prior periods. Within Enterprise Solutions revenue, there was a decrease in revenue from our service assurance, automation and data management products, partially offset by an increase in revenue attributable to our ITKO and Nimsoft products. Enterprise Solutions operating margin for fiscal 2013 increased by one percentage point from 8 percent to 9 percent as a result of the income from the aforementioned $35 million intellectual property transaction in the first quarter of fiscal 2013, which contributed two percentage points to operating margin in fiscal 2013, as well as a decrease in severance costs compared with fiscal 2012. These favorable items were offset by our additional investments in ITKO and Nimsoft products. For fiscal 2012, Enterprise Solutions revenue increased $197 million from fiscal 2011 primarily due to growth in revenue from our security (identity and access management), virtualization and service automation and service and portfolio management products. Revenue from these products is recognized in either subscription and maintenance revenue or software fees and other revenue. Enterprise Solutions revenue was also positively affected by $25 million from the five-year license agreement with a large IT outsourcer executed in the fourth quarter of fiscal 2011. For fiscal 2012, Enterprise Solutions revenue reflected a favorable foreign exchange effect of $29 million compared with fiscal 2011. Enterprise Solutions operating margin for each of fiscal 2012 and fiscal 2011 was 8%. Operating margin was affected by an increase in revenue for fiscal 2012, offset by the increased development investment and selling and marketing expenses within our Enterprise Solutions segment, as well as a severance costs of $19 million in fiscal 2012. Services Fiscal 2013 Fiscal 2012 Fiscal 2011 Revenue $ 382 $ 382 $ 327 Expenses 358 359 310 Segment profit $ 24 $ 23 $ 17 Segment operating margin 6 % 6 % 5 % Service segment expenses include cost of professional services and assigned general and administrative expenses that are not included in the cost of professional services expense lines of the Consolidated Statement of Operations. For fiscal 2013, Services revenue and expenses compared with fiscal 2012 remained consistent. Services operating margin was 6% for each of fiscal 2013 and fiscal 2012. For fiscal 2012, Services revenue and expenses compared with fiscal 2011 increased primarily as a result of our fiscal 2012 acquisition of Base Technologies. For fiscal 2012, Services revenue reflected a favorable foreign exchange effect of $7 million compared with fiscal 2011. For fiscal 2012 compared with fiscal 2011, Services operating margin remained consistent. Refer to Note 17, "Segment and Geographic Information," in the Notes to the Consolidated Financial Statements for additional information. Bookings For fiscal 2013 and fiscal 2012, total bookings were $4,114 million and $4,663 million, respectively. The decrease in total bookings was primarily a result of a year-over-year decline in mainframe renewals, enterprise and mainframe new product sales and mainframe capacity sales reflected in subscription and maintenance bookings and to a lesser extent a decrease in professional services bookings. This decrease was slightly offset by an increase in software fees and other bookings that are or will be recognized as software fees and other revenue and were primarily driven by growth in our SaaS offerings. For fiscal 2012, software fees and other bookings included the $39 million Final License Payment. In fiscal 2013, total bookings decreased compared with fiscal 2012 in the United States and Europe, Middle East and Africa regions and increased in the Asia Pacific Japan and Latin America regions. Total new product and mainframe capacity sales in fiscal 2013 declined by approximately 20% compared with fiscal 2012. Within these bookings, new product and capacity sales decreased in all regions except in the Asia Pacific Japan region. 35-------------------------------------------------------------------------------- Table of Contents Generally, periods with smaller renewal inventories result in a lower level of bookings both because renewal bookings will be lower and, to a lesser extent, because renewals also remain an important selling opportunity for new products. Mainframe new product and capacity sales were down in fiscal 2013 compared with fiscal 2012 primarily due to lower renewals, which were down to a greater extent in the first quarter. Enterprise solutions new product sales declined primarily due to our lower-than-expected sales of new products outside of our renewal process. Bookings performance was also negatively affected by a difficult macroeconomic environment. During the first quarter of fiscal 2013, bookings performance was unexpectedly disrupted by our efforts to align our sales force to execute our customer segmented go-to-market initiative. Although our customer segmentation initiative is taking longer than anticipated to produce expected results, we continue to believe that this initiative will benefit our performance in the long-term. For fiscal 2012 and fiscal 2011, total bookings were $4,663 million and $4,888 million, respectively. The decrease in total bookings was primarily a result of a license renewal agreement with a large IT outsourcer for approximately $500 million, which was executed in the fourth quarter of fiscal 2011 and is included in subscription and maintenance bookings. This decrease was partially offset by an increase in bookings that are recognized as software fees and other revenue. In addition, there was an increase in professional services bookings primarily attributable to an increase in the number of professional services engagements entered into during the fourth quarter of fiscal 2012 and to a lesser extent our fiscal 2012 acquisition of Base Technologies. For fiscal 2012, total bookings from new product and capacity sales increased by a low single digit percentage from fiscal 2011. The increase was primarily a result of new product sales within the Mainframe Solutions segment, which includes the aforementioned Final License Payment. This increase was partially offset by a decrease in Enterprise Solutions segment new product sales. Mainframe capacity sales for fiscal 2012 were consistent with fiscal 2011. Bookings in the United States for fiscal 2012 decreased from fiscal 2011, primarily due to the aforementioned fiscal 2011 license agreement with a large IT outsourcer executed in the fourth quarter of fiscal 2011. This decrease was partially offset by the increase in professional services bookings and the new product sales within the Mainframe Solutions segment. Total international bookings for fiscal 2012 increased from fiscal 2011. Bookings in Latin America for fiscal 2012 increased primarily as a result of an increase in renewals and an increase in new product and capacity sales in fiscal 2012. Bookings in Asia-Pacific-Japan region for fiscal 2012 increased from fiscal 2011 primarily due to an increase in renewals and new product and capacity sales. Total bookings in the Europe, Middle East and Africa region increased slightly for fiscal 2012, primarily due to a large multi-year contract with a financial institution in Europe executed in the fourth quarter of fiscal 2012. Subscription and Maintenance Bookings For fiscal 2013 and fiscal 2012, subscription and maintenance bookings were $3,238 million and $3,776 million, respectively. The decrease in subscription and maintenance bookings was primarily attributable to lower mainframe renewals, and lower enterprise and mainframe new product sales and mainframe capacity sales reflected in subscription and maintenance bookings. Within renewals, the decrease in mainframe renewals was primarily attributable to the composition of the renewal portfolio. This decrease was partially offset by an increase in enterprise solutions renewals. During fiscal 2013, we renewed a total of 52 license agreements with incremental contract values in excess of $10 million each, for an aggregate contract value of $1,514 million. During fiscal 2012, we renewed a total of 57 license agreements with incremental contract values in excess of $10 million each, for an aggregate contract value of $1,722 million. For fiscal 2012 and fiscal 2011, subscription and maintenance bookings were $3,776 million and $4,256 million, respectively. Subscription and maintenance bookings for fiscal 2011, includes a five-year license renewal agreement with a large IT outsourcer for approximately $500 million, which was executed in the fourth quarter of fiscal 2011. Renewal bookings, which generally do not include new product and capacity sales and professional services arrangements, for fiscal 2013 declined by a high single digit percentage compared with fiscal 2012, which is slightly better than the previous expectation of a decline of approximately 10%. For the fourth quarter of fiscal 2013, our percentage renewal yield was in the low 90% range. We currently expect the value of our fiscal 2014 renewals to increase by a percentage in the high single digits, excluding a large customer renewal that is expected to occur in the fourth quarter of fiscal 2014, compared with fiscal 2013. We expect a majority of the increase in renewals to occur in the second half of fiscal 2014. Annualized subscription and maintenance bookings is an indicator that normalizes the bookings recorded in the current period to account for contract length. It is calculated by dividing the total value of all new subscription and maintenance license agreements entered into during a period by the weighted average subscription and license agreement duration in years for all such subscription and maintenance license agreements recorded during the same period. Annualized subscription and maintenance bookings decreased from $1,091 million in fiscal 2012 to $990 million in fiscal 2013 due to the decrease in subscription and maintenance bookings from fiscal 2012 to fiscal 2013. The weighted average subscription and maintenance license agreement duration in years decreased from 3.46 in fiscal 2012 to 3.27 in fiscal 2013. This decrease was primarily attributable to shorter durations associated with large contract renewals in fiscal 2013 compared with the durations of large contract renewals from fiscal 2012. 36-------------------------------------------------------------------------------- Table of Contents Although each contract is subject to terms negotiated by the respective parties, we do not currently expect the weighted average subscription and maintenance agreement duration in years to change materially from historical levels for end-user contracts. Selected Quarterly Information Fiscal 2013 Quarter Ended June 30 September 30 December 31 March 31 Total (dollars in millions, except per share amounts) Revenue $ 1,145 $ 1,152 $ 1,195 $ 1,151 $ 4,643 Percentage of annual revenue 24 % 25 % 26 % 25 % 100 % Costs of licensing and maintenance $ 69 $ 69 $ 72 $ 74 $ 284 Cost of professional services $ 86 $ 88 $ 92 $ 88 $ 354 Amortization of capitalized software costs (1) $ 64 $ 67 $ 66 $ 122 $ 319 Income from continuing operations $ 240 $ 222 $ 251 $ 242 $ 955 Basic income per common share from continuing operations $ 0.51 $ 0.48 $ 0.55 $ 0.53 $ 2.07 Diluted income per common share from continuing operations $ 0.51 $ 0.48 $ 0.55 $ 0.53 $ 2.07 (1) Includes impairment of $55 million in the fourth quarter of fiscal 2013 relating to purchased software (see Note 6, "Long Lived Assets," in the Notes to the Consolidated Financial Statements for additional information). Fiscal 2012 Quarter Ended June 30 September 30 December 31 March 31 Total (dollars in millions, except per share amounts) Revenue $ 1,163 $ 1,200 $ 1,263 $ 1,188 $ 4,814 Percentage of annual revenue 24 % 25 % 26 % 25 % 100 % Costs of licensing and maintenance $ 67 $ 71 $ 69 $ 79 $ 286 Cost of professional services $ 88 $ 91 $ 91 $ 87 $ 357 Amortization of capitalized software costs $ 50 $ 55 $ 59 $ 61 $ 225 Income from continuing operations $ 228 $ 236 $ 263 $ 211 $ 938 Basic income per common share from continuing operations $ 0.45 $ 0.47 $ 0.54 $ 0.45 $ 1.91 Diluted income per common share from continuing operations $ 0.45 $ 0.47 $ 0.54 $ 0.45 $ 1.90 Liquidity and Capital Resources Our cash and cash equivalent balances are held in numerous locations throughout the world, with 62% held in our subsidiaries outside the United States at March 31, 2013. Cash and cash equivalents totaled $2,593 million at March 31, 2013, representing a decrease of $86 million from the March 31, 2012 balance of $2,679 million. The decrease in cash was primarily a result of our payment of dividends, repurchases of our common stock and our purchase of short-term investments, partially offset by net cash provided by operating activities from continuing operations in fiscal 2013. During fiscal 2013, there was an $83 million unfavorable translation effect from foreign currency exchange rates on cash held outside the United States in currencies other than the U.S. dollar. Although 62% of our cash and cash equivalents is held by foreign subsidiaries, we currently neither intend nor expect a need to repatriate these funds to the United States in the foreseeable future. We expect existing domestic cash, cash equivalents, and cash flows from operations to be sufficient to fund our domestic operating activities and our investing and financing activities, including, among other things, the payment of regular quarterly dividends, compliance with our debt repayment schedules, repurchases of our common stock and the funding of capital expenditures, for at least the next 12 months and for the foreseeable future thereafter. In addition, we expect existing foreign cash, cash equivalents and cash flows from foreign operations to be sufficient to fund our foreign operating activities and investing activities, including, among other things, the funding of capital expenditures, acquisitions and research and development, for at least the next 12 months and for the foreseeable future thereafter. 37-------------------------------------------------------------------------------- Table of Contents Sources and Uses of Cash Under our subscription and maintenance agreements, customers generally make installment payments over the term of the agreement, often with at least one payment due at contract execution, for the right to use our software products and receive product support, software fixes and new products when available. The timing and actual amounts of cash received from committed customer installment payments under any specific agreement can be affected by several factors, including the time value of money and the customer's credit rating. Often, the amount received is the result of direct negotiations with the customer when establishing pricing and payment terms. In certain instances, the customer negotiates a price for a single up-front installment payment and seeks its own internal or external financing sources. In other instances, we may assist the customer by arranging financing on the customer's behalf through a third-party financial institution. Alternatively, we may decide to transfer our rights to the future committed installment payments due under the license agreement to a third-party financial institution in exchange for a cash payment. Once transferred, the future committed installments are payable by the customer to the third-party financial institution. Whether the future committed installments have been financed directly by the customer with our assistance or by the transfer of our rights to future committed installments to a third party, these financing agreements may contain limited recourse provisions with respect to our continued performance under the license agreements. Based on our historical experience, we believe that any liability that we may incur as a result of these limited recourse provisions will be immaterial. Amounts billed or collected as a result of a single installment for the entire contract value, or a substantial portion of the contract value, rather than being invoiced and collected over the life of the license agreement, are reflected in the liability section of our Consolidated Balance Sheets as "Deferred revenue (billed or collected)." Amounts received from either a customer or a third-party financial institution that are attributable to later years of a license agreement have a positive impact on billings and cash provided by operating activities in the current period. Accordingly, to the extent these collections are attributable to the later years of a license agreement, billings and cash provided by operating activities during the license's later years will be lower than if the payments were received over the license term. We are unable to predict with certainty the amount of cash to be collected from single installments for the entire contract value, or a substantial portion of the contract value, under new or renewed license agreements to be executed in future periods. For fiscal 2013, gross receipts related to single installments for the entire contract value, or a substantial portion of the contract value, were $672 million compared with $479 million in fiscal 2012. In any quarter, we may receive payments in advance of the contractually committed date on which the payments were otherwise due. In limited circumstances, we may offer discounts to customers to ensure payment in the current period of invoices that have been billed, but might not otherwise be paid until a subsequent period because of payment terms. Historically, any such discounts have not been material. Amounts due from customers from our subscription licenses are offset by deferred revenue related to these license agreements, leaving no or minimal net carrying value on our Consolidated Balance Sheets for those amounts. The fair value of these amounts may exceed or be less than this carrying value but cannot be practically assessed since there is no existing market for a pool of customer receivables with contractual commitments similar to those owned by us. The actual fair value may not be known until these amounts are sold, securitized or collected. Although these customer license agreements commit the customer to payment under a fixed schedule, to the extent amounts are not yet due and payable by the customer, the agreements are considered executory in nature due to our ongoing commitment to provide maintenance and unspecified future software products as part of the agreement terms. 38-------------------------------------------------------------------------------- Table of Contents We can estimate the total amounts to be billed from committed contracts, referred to as our "billings backlog," and the total amount to be recognized as revenue from committed contracts, referred to as our "revenue backlog." The aggregate amounts of our billings backlog and trade receivables already reflected in our Consolidated Balance Sheets represent the amounts we expect to collect in the future from committed contracts. March 31, 2013 March 31, 2012 (in millions) Billings backlog: Amounts to be billed - current $ 2,142 $ 2,220 Amounts to be billed - noncurrent 2,175 2,623 Total billings backlog $ 4,317 $ 4,843 Revenue backlog: Revenue to be recognized within the next 12 months - current $ 3,563 $ 3,714 Revenue to be recognized beyond the next 12 months - noncurrent 4,211 4,759 Total revenue backlog $ 7,774 $ 8,473 Deferred revenue (billed or collected) $ 3,457 $ 3,630 Total billings backlog 4,317 4,843 Total revenue backlog $ 7,774 $ 8,473 Note: Revenue backlog includes deferred subscription and maintenance and professional services revenue. We can also estimate the total cash to be collected in the future from committed contracts, referred to as our "Expected future cash collections," by adding the total billings backlog to the trade accounts receivable, which represent amounts already billed but not collected, from our Consolidated Balance Sheets. March 31, 2013 March 31, 2012 (in millions) Expected future cash collections: Total billings backlog $ 4,317 $ 4,843 Trade accounts receivable, net 856 902 Total expected future cash collections $ 5,173 $ 5,745 The decrease in total billings backlog in fiscal 2013 compared with fiscal 2012 was primarily driven by a decrease in total bookings. The decrease in total expected future cash collections in fiscal 2013 compared with fiscal 2012 was primarily driven by a decrease in billings backlog and to a lesser extent a decrease in trade accounts receivable. The decrease in total revenue backlog in fiscal 2013 compared with fiscal 2012 was primarily due to the decline of total bookings in fiscal 2013 and prior periods and the increase in the percentage of bookings recognized as software fees and other revenue in fiscal 2013, which is not included in revenue backlog. Revenue to be recognized in the next 12 months decreased by 4% at March 31, 2013 compared with March 31, 2012. Excluding the effect of foreign exchange, revenue to be recognized in the next 12 months decreased by 3% at March 31, 2013 compared with March 31, 2012. Based on fiscal 2013 performance and our expectation that our renewal portfolio for fiscal 2014 will be back-end loaded, we expect a continued decline in current revenue backlog into the second half of fiscal 2014. Generally, we believe that an increase or decrease in the current portion of revenue backlog on a year-over-year basis is a favorable or unfavorable indicator of future subscription and maintenance revenue performance, respectively, due to the high percentage of our revenue that is recognized from license agreements that are already committed and being recognized ratably. Unbilled amounts relating to subscription licenses are mostly collectible over a period of one-to-five years and at March 31, 2013, on a cumulative basis, 50%, 80%, 94%, 98% and 100% come due within fiscal 2014 through 2018, respectively. 39-------------------------------------------------------------------------------- Table of Contents Cash Provided by Operating Activities Year Ended March 31, $ Change 2013 2012 2011 2013 / 2012 2012 / 2011 (in millions) Cash collections from billings(1) $ 4,857 $ 5,142 $ 4,774 $ (285 ) $ 368 Vendor disbursements and payroll(1) (3,116 ) (3,235 ) (3,075 ) 119 (160 ) Income tax payments (333 ) (420 ) (222 ) 87 (198 ) Other disbursements, net(2) - 18 (100 ) (18 ) 118 Cash provided by operating activities $ 1,408 $ 1,505 $ 1,377 $ (97 ) $ 128 (1) Amounts include value added taxes and sales taxes. (2) Amounts include interest, restructuring and miscellaneous receipts and disbursements. Fiscal 2013 versus Fiscal 2012 Operating Activities: Cash provided by continuing operating activities for fiscal 2013 was $1,408 million, representing a decrease of $97 million compared with fiscal 2012. The decrease was primarily due to a decrease in cash collections of $285 million from lower billings, partially offset by a decrease in vendor disbursements, payroll and other disbursements, net of $101 million and a decrease in income tax payments of $87 million. For fiscal 2013, there was an increase cash collections from single installment payments of $193 million. For fiscal 2013, other disbursements, net includes $35 million in cash proceeds received as other income from the aforementioned intellectual property transaction that occurred in the first quarter of fiscal 2013. Product development and enhancements expenses are expected to increase in future periods as the amount capitalized for internally developed software costs decreases (see "Amortization of Capitalized Software Costs" above). This will result in additional operating cash outflows relating to development expenses for fiscal 2014. In addition, we currently expect the payments associated with our fiscal 2014 re-balancing actions of approximately $100 million (see Note 19, "Subsequent Events," in the Notes to the Consolidated Financial Statements for additional information) and an increase in cash taxes to have unfavorable effects on cash flows from operations for fiscal 2014. As a result, we expect a year-over-year decrease in cash flows from operations for fiscal 2014 compared with fiscal 2013. Investing Activities: Cash used in continuing investing activities for fiscal 2013 was $473 million compared with $455 million for fiscal 2012. The increase in cash used in continuing investing activities was primarily due to an increase in cash paid for investments of $238 million and a decrease in cash received from investment sales and maturities of $124 million, partially offset by a decrease in cash paid for acquisitions of $311 million, a decrease in purchases of property and equipment of $22 million, and a decrease in capitalized software development costs of $15 million. As described above, product development and enhancements expenses are expected to increase in future periods as the amount capitalized for internally developed software costs decreases. This will have no effect on total cash flows, but will reduce our outflows from investing activities and also decrease our operating cash flows. Financing Activities: Cash used in continuing financing activities for fiscal 2013 was $938 million compared with $1,330 million in fiscal 2012. The decrease in cash used in continuing financing activities was primarily due to a decrease in common shares repurchased of $560 million and a decrease in net debt repayments mainly related to our notional pooling arrangement of $114 million, partially offset by an increase in cash dividends paid of $271 million. Refer to the "Debt Arrangements" table below for additional information about our debt balances at March 31, 2013. Fiscal 2012 versus Fiscal 2011 Operating Activities: Cash provided by continuing operating activities for fiscal 2012 was $1,505 million, representing an increase of $128 million compared with fiscal 2011. The increase was primarily due to an increase in cash collections from billings of $368 million, offset by an increase in income tax payments of $198 million and an increase in vendor, payroll and other disbursements of $42 million. 40-------------------------------------------------------------------------------- Table of Contents Investing Activities: Cash used in continuing investing activities for fiscal 2012 was $455 million compared with $700 million for fiscal 2011. The decrease in cash used in continuing investing activities was primarily due to a decrease of $360 million in our net investment activities in marketable securities. During fiscal 2012, proceeds from the sale of investments were $207 million, of which $180 million was due to the liquidation of a majority of our marketable securities portfolio during the fourth quarter of fiscal 2012. This decrease was partially offset by an increase in cash paid for acquisitions of $135 million. Financing Activities: Cash used in continuing financing activities for fiscal 2012 was $1,330 million compared with $320 million in fiscal 2011. The increase in cash used in continuing financing activities was primarily due to an increase in common shares repurchased of $818 million, the repayment of $250 million under our revolving credit facility due August 2012 and an increase in annual dividends paid of $110 million as a result of the new capital allocation program approved by our Board of Directors during the fourth quarter of fiscal 2012. These increases were partially offset by an increase in borrowing positions outstanding of $139 million relating to our notional pooling arrangement. Refer to the "Debt Arrangements" table below for additional information about our debt balances at March 31, 2012. Debt Arrangements Our debt arrangements consisted of the following: At March 31, 2013 2012 (in millions) Revolving credit facility due August 2016 - - 5.375% Notes due November 2019 750 750 6.125% Notes due December 2014, net of unamortized premium from fair value hedge of $19 and $27 519 527 Other indebtedness, primarily capital leases 26 29 Unamortized discount for Notes (5 ) (5 ) Total debt outstanding $ 1,290 $ 1,301 Less the current portion (16 ) (14 ) Total long-term debt portion $ 1,274 $ 1,287 We have entered into interest rate swaps to convert $500 million of our 6.125% Notes into floating interest rate payments through December 1, 2014. Under the terms of the swaps, we will pay quarterly interest at an average rate of 2.88% plus the three-month LIBOR rate, and will receive payment at 5.625%. The LIBOR based rate is set quarterly three months prior to the date of the interest payment. At March 31, 2013, the fair value of these derivatives was an asset of $19 million, of which $11 million is included in "Other current assets" and $8 million is included in "Other noncurrent assets, net" in the Consolidated Balance Sheet. The carrying value of the 6.125% Notes was adjusted by an amount that is equal and offsetting to the fair value of the swaps. In April 2011, we repaid the $250 million outstanding balance of our revolving credit facility that was due August 2012. In August 2011, we replaced the revolving credit facility due August 2012 with a new revolving credit facility due August 2016. The maximum committed amount available under the revolving credit facility due August 2016 is $1 billion. The facility also provides us with an option to increase the available credit by an amount up to $500 million. This option is subject to certain conditions and the agreement of the facility lenders. At March 31, 2013, our senior unsecured notes were rated Baa2 (stable) by Moody's Investor Services, BBB+ (stable) by Standard and Poor's, and BBB+ (stable) by Fitch Ratings. From time to time, we examine our debt balances in light of market conditions and other factors and thus, the levels of our debt balances may change. For further information on our debt balances, refer to Note 8, "Debt," in the Notes to the Consolidated Financial Statements. 41-------------------------------------------------------------------------------- Table of Contents Stock Repurchases Under the $2.5 billion capital allocation program approved by our Board of Directors on January 23, 2012, we are authorized to acquire up to $1.5 billion of our common stock through fiscal 2014, including $232 million remaining at December 31, 2011 under our previous share repurchase authorizations. As part of the capital allocation program, we entered into an accelerated share repurchase agreement with a bank in the fourth quarter of fiscal 2012 to purchase $500 million of our common stock. Under the agreement, we paid $500 million to the bank for an initial delivery of 15 million shares. The fair market value of 15 million shares on the date received was $375 million and was included in "Treasury stock" in our Consolidated Balance Sheet at March 31, 2012. The remaining $125 million was included in "Additional paid-in capital" in our Consolidated Balance Sheet at March 31, 2012. The accelerated share repurchase transaction was completed in the first quarter of fiscal 2013 and we received 3.7 million additional shares, at which time the initial amount recorded as additional paid-in capital was reclassified to treasury stock. The final number of shares delivered upon settlement of the agreement was determined based on the average price of our common stock over the term of the accelerated share repurchase agreement. During fiscal 2013, excluding the accelerated share repurchase transaction, we repurchased 20 million shares of our common stock for $495 million. At March 31, 2013, we remained authorized to purchase $505 million of our common stock under our current stock repurchase program. The timing and amount of share repurchases will be determined by our management based on evaluation of market conditions, trading price, legal requirements, and other factors. Dividends We have paid cash dividends each year since July 1990. For fiscal 2013, 2012 and 2011, we paid annual cash dividends of $1.00, $0.40 and $0.16 per share, respectively. On January 23, 2012, our Board of Directors approved a capital allocation program that targets the return of up to $2.5 billion to shareholders through fiscal 2014. This included an increase in the annual dividend from $0.20 to $1.00 per share on our common stock as and when declared by the Board of Directors. For fiscal 2013, we paid quarterly cash dividends of $0.25 per share. We paid a cash dividend of $0.25 per share in the fourth quarter of fiscal 2012 and $0.05 per share in each of the first three quarters of fiscal 2012. For fiscal 2011, we paid quarterly cash dividends of $0.04 per share. Effect of Foreign Currency Exchange Rate Changes There was a $83 million unfavorable impact to our cash balances in fiscal 2013 predominantly due to the strengthening of the U.S. dollar against the euro (4%), the Brazilian real (10%) and the Japanese yen (12%). There was a $67 million unfavorable impact to our cash balances in fiscal 2012 predominantly due to the strengthening of the U.S. dollar against the euro (6%), Brazilian real (12%), Canadian dollar (3%), South African rand (13%) and Indian rupee (14%). Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements with unconsolidated entities or related parties and, accordingly, off-balance sheet risks to our liquidity and capital resources from unconsolidated entities are limited. Contractual Obligations and Commitments We have commitments under certain contractual arrangements to make future payments for goods and services. These contractual arrangements secure the rights to various assets and services to be used in the future in the normal course of business. For example, we are contractually committed to make certain minimum lease payments for the use of property under operating lease agreements. In accordance with current accounting rules, the future rights and related obligations pertaining to such contractual arrangements are not reported as assets or liabilities on our Consolidated Balance Sheets. We expect to fund these contractual arrangements with cash generated from operations in the normal course of business. 42-------------------------------------------------------------------------------- Table of Contents The following table summarizes our contractual arrangements at March 31, 2013 and the timing and effect that those commitments are expected to have on our liquidity and cash flow in future periods. In addition, the table summarizes the timing of payments on our debt obligations as reported on our Consolidated Balance Sheet at March 31, 2013. Payments Due By Period Less Than 1-3 3-5 More Than Contractual Obligations Total 1 Year Years Years 5 Years (in millions) Long-term debt obligations (inclusive of interest) $ 1,567 $ 54 $ 600 $ 82 $ 831 Operating lease obligations(1) 497 97 154 106 140 Purchase obligations 81 65 10 6 - Other obligations(2) 59 30 20 5 4 Total $ 2,204 $ 246 $ 784 $ 199 $ 975 (1) The contractual obligations for noncurrent operating leases exclude sublease income totaling $24 million expected to be received in the following periods: $5 million (less than 1 year); $7 million (1-3 years); $4 million (3-5 years); and $8 million (more than 5 years). (2) $486 million of estimated liabilities related to unrecognized tax benefits are excluded from the contractual obligations table because we could not make a reasonable estimate of when those amounts will become payable. Critical Accounting Policies and Estimates We review our financial reporting and disclosure practices and accounting policies quarterly to help ensure that they provide accurate and transparent information relative to the current economic and business environment. Note 1, "Significant Accounting Policies" in the Notes to the Consolidated Financial Statements contains a summary of the significant accounting policies that we use. Many of these accounting policies involve complex situations and require a high degree of judgment, either in the application and interpretation of existing accounting literature or in the development of estimates that affect our financial statements. On an ongoing basis, we evaluate our estimates and judgments based on historical experience as well as other factors that we believe to be reasonable under the circumstances. These estimates may change in the future if underlying assumptions or factors change. We consider the following significant accounting policies to be critical because of their complexity and the high degree of judgment involved in implementing them. Revenue Recognition We generate revenue from the following primary sources: (1) licensing software products, including SaaS license agreements; (2) providing customer technical support (referred to as maintenance); and (3) providing professional services, such as product implementation, consulting and education. Software license agreements under our subscription model include the right to receive and use unspecified future software products for no additional fee during the term of the agreement. We are required under generally accepted accounting principles (GAAP) to recognize revenue from these subscription licenses ratably over the term of the agreement. These amounts are recorded as subscription and maintenance revenue. We also license our software products without the right to unspecified future software products. Revenue from these arrangements is either recognized at the inception of the license agreement (up-front basis) or ratably over the term of any maintenance agreement that is bundled with the license. Revenue is recognized up-front only when we have established VSOE for all of the undelivered elements of the agreement. We use the residual method to determine the amount of license revenue to be recognized up-front. The residual method allocates arrangement consideration to the undelivered elements based upon VSOE of the fair value of those elements, with the residual of the arrangement consideration allocated to the license. The portion allocated to the license is recognized "up-front" once all four of the revenue recognition criteria are met. We establish VSOE of the fair value of maintenance from either contractually stated renewal rates or using the bell-shaped curve method. VSOE of the fair value of professional services is established based on hourly rates when sold on a stand-alone basis. Up-front revenue is recorded as Software Fees and Other. Revenue recognized on an up-front model will result in higher total revenue in a reporting period than if that revenue was recognized ratably. If VSOE does not exist for all undelivered elements of an arrangement, we recognize total revenue from the arrangement ratably over the term of the maintenance agreement. Revenue recognized ratably is recorded as "Subscription and maintenance revenue." 43-------------------------------------------------------------------------------- Table of Contents Revenue recognition does not commence until (1) we have evidence of an arrangement with a customer; (2) we deliver the specified products; (3) license agreement terms are fixed or determinable and free of contingencies or uncertainties that may alter the agreement such that it may not be complete and final; and (4) collection is probable. Revenue from sales to distributors and volume partners, value-added resellers and exclusive representatives commences, either on an up-front basis or ratably as described above, when these entities sell the software product to their customers. This is commonly referred to as the sell-through method. Revenue from professional service arrangements is generally recognized as the services are performed. Revenue and costs from committed professional services that are sold as part of a software license agreement are deferred and recognized on a ratable basis over the life of the related software transaction. In the event that agreements with our customers are executed in close proximity of other license agreements with the same customer, we evaluate whether the separate arrangements are linked, and, if so, they are considered a single multi-element arrangement for which revenue is recognized ratably as "Subscription and maintenance revenue" in the Consolidated Statements of Operations. In the case of a professional services arrangement that is linked to a subscription-based software license arrangement, revenue is recognized as "Professional services" for its respective portion, in the Consolidated Statements of Operations. We have an established business practice of offering installment payment options to customers and a history of successfully collecting substantially all amounts due under those agreements. We assess collectability based on a number of factors, including past transaction history with the customer and the creditworthiness of the customer. If, in our judgment, collection of a fee is not probable, we will not recognize revenue until the uncertainty is removed through the receipt of cash payment. We do not typically offer installment payments for perpetual license agreements that are recognized up-front, within "Software fees and other." See Note 1, "Significant Accounting Policies" for additional information on our revenue recognition policy. Accounts Receivable The allowance for doubtful accounts is a reserve for the impairment of accounts receivable on the Consolidated Balance Sheets. In developing the estimate for the allowance for doubtful accounts, we rely on several factors, including: • Historical information, such as general collection history of multi-year software agreements; • Current customer information and events, such as extended delinquency, requests for restructuring and filings for bankruptcy; • Results of analyzing historical and current data; and • The overall macroeconomic environment. The allowance includes two components: (1) specifically identified receivables that are reviewed for impairment when, based on current information, we do not expect to collect the full amount due from the customer; and (2) an allowance for losses inherent in the remaining receivable portfolio based on historical activity. Income Taxes We account for income taxes under the asset and liability method. We recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, along with net operating losses and tax credit carryforwards. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We recognize the effect on deferred tax assets and liabilities of a change in tax rates on income in the period that includes the enactment date. We recognize the effect of income tax positions only if those positions are more likely than not of being sustained. We utilize a "more likely than not" threshold for the recognition and derecognition of tax positions and measure positions accordingly. We reflect changes in recognition or measurement in a period in which the change in judgment occurs. We record interest and penalties related to uncertain tax positions in income tax expense. Goodwill, Capitalized Software Products, and Other Intangible Assets Goodwill is tested for impairment at least annually in the fourth quarter of our fiscal year. We may first perform a qualitative assessment of whether it is more likely than not that a reporting unit's fair value is less than its carrying amount, and, if so, we then apply the two-step impairment test. The two-step impairment test first compares the fair value of our reporting units, which are the same as our operating segments, to their carrying (i.e., book) value. If the fair value of the reporting unit exceeds its carrying value, goodwill is not impaired and we are not required to perform further testing. If the carrying value of the reporting unit exceeds its fair value, we determine the implied fair value of the reporting unit's goodwill and if the carrying value of the reporting unit's goodwill exceeds its implied fair value, then we record an impairment loss equal to the difference. 44-------------------------------------------------------------------------------- Table of Contents Based on our impairment analysis in the fourth quarter of fiscal 2013, we determined that the fair value of each of our reporting units exceeded the carrying value of the unit by more than 10% of the carrying value. We determine the fair value of our reporting units based on use of income and market approaches. Under the income approach, we calculate the fair value of a reporting unit based on the present value of estimated future cash flows. Determining the fair value of a reporting unit involves the use of significant estimates and assumptions. These estimates and assumptions include the revenue growth rates and operating profit margins that are used to project future cash flows, discount rates, future economic and market conditions and determination of appropriate market comparables. We make certain judgments and assumptions in allocating shared costs among reporting units. We base our fair value estimates on assumptions that are consistent with information used by the business for planning purposes and that we believe to be reasonable; however, actual future results may differ from those estimates. Changes in judgments on any of these factors could materially affect the value of the reporting unit. The carrying values of capitalized software products, for purchased software, internally developed software and other intangible assets are reviewed for recoverability on a quarterly basis. The facts and circumstances considered include an assessment of the net realizable value for capitalized software products and the recoverability of the cost of other intangible assets from future cash flows to be derived from the use of the asset. It is not possible for us to predict the likelihood of any possible future impairments or, if such an impairment were to occur, the magnitude of any impairment. Intangible assets with finite useful lives are subject to amortization over the expected period of economic benefit to us. We evaluate whether events or circumstances have occurred that warrant a revision to the remaining useful lives of intangible assets. In cases where a revision to the remaining amortization period is deemed appropriate, the remaining carrying amounts of the intangible assets are amortized over the revised remaining useful life. Accounting for Business Combinations The allocation of the purchase price for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the identifiable tangible and intangible assets acquired, including in-process research and development, and liabilities assumed based on their respective fair values. Product Development and Enhancements GAAP specifies that costs incurred internally in researching and developing a computer software product should be charged to expense until technological feasibility has been established for the product. Once technological feasibility is established, all software costs are capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established and assumptions are used that reflect our best estimates and is influenced by our product release strategies and software development methodologies. Annual amortization of capitalized software costs is the greater of the amount computed using the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product or the straight-line method over the remaining estimated economic life of the software product, generally estimated to be five years from the date the product became available for general release to customers. We amortize capitalized software costs using the straight-line method. We expect that our product offerings and go-to-market strategy will be evolving in future periods to include solutions and product suites that may be delivered either on-premises or via SaaS or cloud platforms. These product offerings will become available to customers at more frequent intervals than our historical release cycles. We also expect a more extensive adoption of agile development methodologies which are characterized by a more dynamic development process with more frequent revisions to a product release's features and functions as the software is being developed. These factors will result in us commencing capitalization much later in the development life cycle. As a result, product and development expenses are expected to increase in future periods as the amount of software development costs capitalized decreases. Accounting for Share-Based Compensation We currently maintain several stock-based compensation plans. We use the Black-Scholes option-pricing model to compute the estimated fair value of certain share-based awards. The Black-Scholes model includes assumptions regarding dividend yields, expected volatility, expected lives, and risk-free interest rates. These assumptions reflect our best estimates, but these items involve uncertainties based on market and other conditions outside of our control. As a result, if other assumptions had been used, stock-based compensation expense could have been materially affected. Furthermore, if different assumptions are used in future periods, stock-based compensation expense could be materially affected in future years. As described in Note 14, "Stock Plans," in the Notes to the Consolidated Financial Statements, performance share units (PSUs) are awards under the long-term incentive programs for senior executives where the number of shares or restricted shares, as applicable, ultimately received by the senior executives depends on our performance measured against specified targets and will be determined at the conclusion of the three-year or one-year period, as applicable. The fair value of each award is estimated on the date that the performance targets are established based on the fair value of our stock and our estimate of the level of achievement of our performance targets. We are required to recalculate the fair value of issued PSUs each reporting period until the underlying shares are granted. The adjustment is based on the quoted market price of our stock on the reporting period date. Each quarter, we compare the actual performance we expect to achieve with the performance targets. 45-------------------------------------------------------------------------------- Table of Contents Fair Value of Financial Instruments The measurement of fair value for our financial instruments is based on the authoritative guidance which establishes a fair value hierarchy that is based on three levels of inputs and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. See Note 10, "Fair Value Measurements," for additional information. We are exposed to financial market risks arising from changes in interest rates and foreign exchange rates. Changes in interest rates could affect our monetary assets and liabilities, and foreign exchange rate changes could affect our foreign currency denominated monetary assets and liabilities and forecasted transactions. We enter into derivative contracts with the intent of mitigating a portion of these risks. See Note 9, "Derivatives," for additional information. Legal Contingencies We are currently involved in various legal proceedings and claims. Periodically, we review the status of each significant matter and assess our potential financial exposure. If the potential loss from any legal proceeding or claim is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of the probability of a loss and the determination as to whether the amount of loss is reasonably estimable. Due to the uncertainties related to these matters, the decision to record an accrual and the amount of accruals recorded are based only on the information available at the time. As additional information becomes available, we reassess the potential liability related to our pending litigation and claims, and may revise our estimates. Any revisions could have a material effect on our results of operations. Refer to Note 11, "Commitments and Contingencies," in the Notes to the Consolidated Financial Statements for a description of our material legal proceedings. [ Back To TMCnet.com's Homepage ]