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CA, INC. - 10-Q - : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Cautionary Statement Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q (Form 10-Q) contains certain forward-looking information relating to CA, Inc. (which we refer to as the "Company," "Registrant," "CA Technologies," "CA," "we," "our" or "us"), that is based on the beliefs of, and assumptions made by, our management as well as information currently available to management. When used in this Form 10-Q, the words "believes," "plans," "anticipates," "expects," "estimates," "targets" and similar expressions relating to the future are intended to identify forward-looking information. Forward-looking information includes, for example, the statements relating to the future made in this Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A), but also statements relating to the future that appear in other parts of this Form 10-Q. This forward-looking information reflects our current views with respect to future events and is subject to certain risks, uncertainties and assumptions. The declaration and payment of future dividends is subject to the determination of the Company's Board of Directors, in its sole discretion, after considering various factors, including the Company's financial condition, historical and forecast operating results, and available cash flow, as well as any applicable laws and contractual covenants and any other relevant factors. The Company's practice regarding payment of dividends may be modified at any time and from time to time. Repurchases under the Company's stock repurchase program are expected to be made with cash on hand and may be made from time to time, subject to market conditions and other factors, in the open market, through solicited or unsolicited privately negotiated transactions or otherwise. The program does not obligate the Company to acquire any particular amount of common stock, and it may be modified or suspended at any time at the Company's discretion. A number of important factors could cause actual results or events to differ materially from those indicated by forward-looking statements, including: the ability to achieve success in the Company's strategy by, among other things, effectively managing the Company's sales force to enable the Company to maintain and enhance its strong relationships in its traditional customer base and to increase penetration and accelerate growth in customer segments and geographic regions where the Company currently may not have a strong presence or the Company has underserved, enabling the sales force to sell new products, improving the Company's brand, technology and innovation awareness in the marketplace and ensuring the Company's set of cloud computing, application development and IT operations (DevOps), Software-as-a-Service, mobile device management and other new offerings address the needs of a rapidly changing market, while not adversely affecting the demand for the Company's traditional products or its profitability; global economic factors or political events beyond the Company's control; general economic conditions and credit constraints, or unfavorable economic conditions in a particular region, industry or business sector; the failure to innovate and/or adapt to technological changes and introduce new software products and services in a timely manner; competition in product and service offerings and pricing; the failure to expand partner programs; the ability to retain and attract adequate qualified personnel; the ability of the Company's products to remain compatible with ever-changing operating environments, platforms or third-party products; the ability to successfully integrate acquired companies and products into the Company's existing business; the ability to adequately manage, evolve and protect the Company's information systems, infrastructure and processes; risks associated with sales to government customers; breaches of the Company's data center, network and software products, and the IT environments of the Company's vendors and customers; discovery of errors or omissions in the Company's software products or documentation and potential product liability claims; the failure to protect the Company's intellectual property rights and source code; events or circumstances that would require the Company to record an impairment charge relating to the Company's goodwill or capitalized software and other intangible assets balances; access to software licensed from third parties; risks associated with the use of software from open source code sources; third-party claims of intellectual property infringement or royalty payments; fluctuations in the number, terms and duration of the Company's license agreements as well as the timing of orders from customers and channel partners; the failure to renew large license transactions on a satisfactory basis; potential tax liabilities; changes in market conditions or the Company's credit ratings; fluctuations in foreign currencies; the failure to effectively execute the Company's workforce reductions, workforce rebalancing and facilities consolidations; successful and secure outsourcing of various functions to third parties; and other factors described more fully in this Form 10-Q and the Company's other filings with the Securities and Exchange Commission. Should one or more of these risks or uncertainties occur, or should our assumptions prove incorrect, actual results may vary materially from the forward-looking information described in this Form 10-Q as believed, planned, anticipated, expected, estimated, targeted or similarly identified. We do not intend to update these forward-looking statements, except as otherwise required by law. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. This MD&A is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes to the financial statements. References in this Form 10-Q to fiscal 2015 and fiscal 2014 are to our fiscal years ending on March 31, 2015 and 2014, respectively. 22-------------------------------------------------------------------------------- Table of Contents OVERVIEW We are one of the world's leading providers of information technology (IT) management software and solutions. Our solutions help organizations of all sizes develop, manage, and secure complex IT environments that increase productivity and enhance the competitiveness in their businesses. We do this across a wide range of environments such as mainframe, distributed, cloud, and mobile. The majority of the Global Fortune 500 relies on us to help manage their IT environments. Our objective is to be the world's leading independent software provider for IT management and security solutions to help organizations and enterprises develop, manage, and secure modern IT architectures, across mainframe, distributed, mobile and cloud environments. To accomplish this, key elements of our strategy include: • Innovating in key product areas to extend our market leadership and differentiation. Our product development strategy is built around three key growth areas, where we are focused on innovating and delivering differentiated products and solutions: application development and IT operations (DevOps), Management Cloud, and Security across multiple platforms. • Addressing shifts in market dynamics and technology. We will innovate to deliver new differentiated solutions that enable our customers to manage the challenges and capture the opportunities of disruptive technologies such as the ability to harvest big data, the shift to software-defined IT, the proliferation of mobile technologies, social access (or social credentials) authentication, and the always on, ubiquitously connected "Internet of Things." • Accelerating growth in our global customer base. We are focused on maintaining strong relationships with our core, large enterprise customer base, and will proactively target growth with these customers as well as new large enterprises we do not currently serve. In parallel, we are broadening our customer base to new buyer segments beyond the customer's Chief Information Officer and IT department and increasingly to geographic regions we have underserved. • Pursuing new business models and expanded routes to market. While our traditional on-premise software delivery remains core to our enterprise customers, we see Software-as-a-Service (SaaS) and managed services as increasingly attractive for our customers. This simplifies their decision-making and accelerates the value they can derive from new solution investments. This delivery model allows us to extend our market reach, speed adoption of our solutions, improve our efficiencies, and compete more effectively for a larger number of customers globally. We have a broad and deep portfolio of software solutions with which to execute our business strategy. We organize our offerings in Mainframe Solutions, Enterprise Solutions and Services segments. • Mainframe Solutions products are designed mainly for the IBM System z mainframe platform, which runs many of our largest customers' mission-critical applications. We help customers seamlessly manage their mainframe as part of their evolving data center through flexible management approaches, cross-platform visibility and workload portability. • Enterprise Solutions products operate on non-mainframe platforms and include our DevOps, Management Cloud, and Security product groups. DevOps includes application delivery, application performance management and infrastructure management. Management Cloud helps customers optimize their investments, projects, resources and processes. Security delivers identity-centric security solutions to meet the needs of today's mobile, cloud-connected, open enterprise. • Services helps customers reach their IT and business goals by enabling the rapid implementation and adoption of our mainframe solutions and enterprise solutions. Our traditional core customers generally consist of large enterprises that have computing environments from multiple vendors and are highly complex. We currently serve customers across most major industries worldwide, including banks, insurance companies, other financial services providers, government agencies, global service providers, telecommunication providers, manufacturers, technology companies, retailers, educational organizations and health care institutions. We offer our solutions through our direct sales force and indirectly through our partners. We remain focused on strengthening relationships with our core customers--which we refer to as our "Platinum" customers, consisting of our top 500 accounts-- through product leadership, account management and a differentiated customer experience. We believe enhanced relationships in our traditional customer base of large enterprises with multi-year enterprise license agreements will drive renewals and provide opportunities to increase account penetration that will help to drive revenue growth. At the same time, we continue to dedicate sales resources and deploy additional solutions to address opportunities to sell to new enterprises and to expand our relationship with existing non-core customers--which we refer to as our "Named" customers. In addition to this dedication of additional sales resources, we service some of these customers through partners. We believe we can grow our business and increase market share by delivering differentiated technology and collaborating with partners, including service providers, to leverage their relationships, market reach and implementation capacity. We are deploying new routes to market, and simplifying the buying and deployment process for our customers. This customer focus allows us to better align marketing and sales resources with how customers want to buy. We have also implemented broad-based business initiatives to drive accountability for sales execution. 23-------------------------------------------------------------------------------- Table of Contents Work is underway to deploy an updated global branding and marketing program for CA Technologies to significantly enhance our connection with new and existing customers, introduce the market to new areas of our capability and contribute directly to business growth and new customer acquisitions. Marketing efforts are key to our ability to expand our customer base, reach new segments and grow in key global markets. EXECUTIVE SUMMARY In the second quarter, we continued to see traction against our strategic and operational goals, including an increase in our enterprise solutions new product sales for the second consecutive quarter. We also continued to see strong performance in connection with renewals and financial discipline across the business. Lastly, we completed our divestiture of the CA arcserve data protection business (arcserve). A summary of key results for the second quarter of fiscal 2015 compared with the second quarter of fiscal 2014 is as follows: Revenue: • Total revenue declined 2% primarily as a result of a decrease in subscription and maintenance revenue, which was primarily due to a decrease in Mainframe Solutions revenue and, to a lesser extent, a decrease in professional services revenue. The decrease in professional services revenue was primarily due to a decrease in the size and number of professional services engagements during the first quarter of fiscal 2015, including non-core engagements with government customers that are not directly related to our software product sales. We currently expect the percentage decline in professional services revenue to be greater than the percentage decline in total revenue for fiscal 2015 compared with fiscal 2014 as a result of the decline in non-core professional services engagements with government customers as referenced above. • As a result of insufficient revenue from prior period new sales to offset the decline in revenue contribution from renewals, we continue to expect a year-over-year decrease in total revenue for fiscal 2015 compared with fiscal 2014 due to the high percentage of our revenue that is recognized from license agreements with customers signed in prior periods that are being recognized ratably. Excluding the effect of foreign exchange, we currently expect the year-over-year percentage decline in total revenue for fiscal 2015 compared with fiscal 2014 to be similar to the year-over-year percentage decline in total revenue for fiscal 2014 compared with fiscal 2013. Bookings: • Total bookings decreased 11% primarily due to an expected year-over-year decrease in renewals within subscription and maintenance bookings, partially offset by an increase in professional services bookings. • Total renewals decreased by a percentage in the low twenties primarily due to the timing of our renewals. This timing reflects the decrease in the value of contracts generally available for renewal compared with the year-ago period. • Total new product sales, a subset of our total bookings, increased by a mid-single-digit percentage. • Mainframe solutions new sales decreased by a percentage in the low twenties primarily due to the timing of our renewals and the composition of the renewal portfolio being more heavily weighted to enterprise solutions renewals in the quarter. • Enterprise solutions new product sales increased by a percentage in the low teens as a result of increased sales in our Named customer accounts in all regions, and to a lesser extent, increased sales in our Platinum customer accounts. • We continue to expect the value of our fiscal 2015 renewal portfolio to decline by a high-single-digit percentage compared with fiscal 2014. Excluding the impact from a contract renewal with a large system integrator that occurred during the third quarter of fiscal 2014, we continue to expect the value of our fiscal 2015 renewal portfolio to be consistent with the value of our fiscal 2014 renewal portfolio. For the third quarter of fiscal 2015, we expect the value of our renewal portfolio to decline, and for the fourth quarter of fiscal 2015, we expect it to increase. Expenses: • Total expenses before interest and income taxes was generally consistent compared with the year-ago period. We expect an increase in selling and marketing expenses in the third quarter of fiscal 2015 as a result of expenses associated with CA World '14, which is scheduled to occur in the third quarter of fiscal 2015. Income taxes: • Income tax expense decreased from $101 million to $73 million due to the overall decrease to income from continuing operations before taxes and the recognition of a discrete tax benefit of $19 million resulting from the resolution of uncertain tax positions in the second quarter of fiscal 2015. • We expect a fiscal 2015 effective tax rate of 30%. 24-------------------------------------------------------------------------------- Table of Contents Diluted income per common share from continuing operations: • Diluted income per common share from continuing operations increased to $0.53 from $0.51, primarily due to the increase in income from continuing operations and the decrease in the weighted average shares outstanding compared with the year-ago period. Segment results: • Mainframe Solutions revenue decreased primarily due to insufficient revenue from prior period new sales to offset the decline in revenue contribution from renewals. Operating margin was generally consistent compared with the year-ago period. • Enterprise Solutions revenue decreased primarily due to a decrease in revenue that is recognized on an up-front basis in the current period. The decline was primarily due to an increase in the percentage of our Enterprise Solutions new sales sold in connection with renewals compared with the year-ago period. In addition, within Enterprise Solutions there was an unfavorable effect from the decrease in revenue from certain mature product lines, partially offset by an increase in revenue from recently acquired products and sales of newly developed technologies. Enterprise Solutions operating margin was generally consistent compared with the year-ago period. • Services revenue decreased primarily as a result of a decrease in the size and number of services engagements during the first quarter of fiscal 2015, including non-core engagements with government customers that are not directly related to our software product sales. We expect the percentage decline in services revenue to be greater than the percentage decline in total revenue for fiscal 2015 compared with fiscal 2014. Operating margin for our Services segment decreased as a result of a number of factors, including the decrease in revenue and lower utilization rates for services personnel due to the decrease in the number of services engagements. Cash flows from continuing operations: • Net cash provided by operating activities from continuing operations decreased $7 million. Net cash provided by operating activities from continuing operations for the second quarter of fiscal 2014 was positively affected by a tax refund of $70 million. Net cash provided by operating activities from continuing operations for the second quarter of fiscal 2015 was positively affected by an increase in cash collections of $97 million. The increase in cash collections was primarily attributable to higher single installment collections of $76 million during the second quarter of fiscal 2015 compared with the second quarter of fiscal 2014. QUARTERLY UPDATE • In July 2014, the Company sold arcserve for $170 million and recognized a gain on disposal of $19 million, including tax expense of $77 million. 25 -------------------------------------------------------------------------------- Table of Contents PERFORMANCE INDICATORS Management uses several quantitative performance indicators to assess our financial results and condition. Following is a summary of the principal quantitative performance indicators that management uses to review performance: Second Quarter Comparison Fiscal Dollar 2015 (1) 2014 (1) Change Percentage Change (dollars in millions) Total revenue $ 1,079 $ 1,105 $ (26 ) (2 )% Income from continuing operations $ 235 $ 231 $ 4 2 % Net cash provided by operating activities - continuing operations $ 66 $ 73 $ (7 ) (10 )% Total bookings $ 749 $ 844 $ (95 ) (11 )% Subscription and maintenance bookings $ 571 $ 695 $ (124 ) (18 )% Weighted average subscription and maintenance license agreement duration in years 3.10 3.32 (0.22 ) (7 )% First Half Comparison Fiscal Dollar 2015 (1) 2014 (1) Change Percentage Change (dollars in millions) Total revenue $ 2,148 $ 2,200 $ (52 ) (2 )% Income from continuing operations $ 447 $ 561 $ (114 ) (20 )% Net cash provided by operating activities - continuing operations $ 232 $ 76 $ 156 205 % Total bookings $ 1,473 $ 1,640 $ (167 ) (10 )% Subscription and maintenance bookings $ 1,174 $ 1,312 $ (138 ) (11 )% Weighted average subscription and maintenance license agreement duration in years 3.22 3.22 - - % Change Change September 30, From September 30, From Prior 2014 March 31, 2014 Year End 2013 Year Quarter (in millions) Cash, cash equivalents and short-term investments (2) $ 3,193 $ 3,252 $ (59 ) $ 2,799 $ 394 Total debt $ 1,763 $ 1,766 $ (3 ) $ 1,779 $ (16 ) Total expected future cash collections from committed contracts (1) (3) $ 4,586 $ 5,148 $ (562 ) $ 4,922 $ (336 ) Total revenue backlog (1) (3) $ 6,811 $ 7,639 $ (828 ) $ 7,153 $ (342 ) Total current revenue backlog (1) (3) $ 3,230 $ 3,500 $ (270 ) $ 3,325 $ (95 ) (1) Information presented excludes the results of our discontinued operations. (2) At September 30, 2014 and March 31, 2014, short-term investments were less than $1 million, respectively. At September 30, 2013, short-term investments were $9 million. (3) Refer to the discussion in the "Liquidity and Capital Resources" section of this MD&A for additional information on expected future cash collections from committed contracts 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. 26-------------------------------------------------------------------------------- Table of Contents 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 Condensed Consolidated Statements of Operations. As our business strategy has evolved, our management looks within total bookings at renewal bookings, which we define as bookings attributable to the renewable value of a prior contract (i.e., the maintenance value and, in the case of non-perpetual licenses, the license value), and at total new product sales, which we define as sales of mainframe and enterprise solutions products, and mainframe solutions capacity that are new or in addition to products or mainframe solutions capacity previously contracted for by a customer. Mainframe solutions new product sales and capacity growth can be inconsistent on both a quarterly and annual basis. We believe the period-over-period change in mainframe solutions new product sales and capacity combined is a more appropriate measure of performance and, therefore, we provide only total mainframe solutions new sales information, which includes mainframe solutions capacity. The amount of new product 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 sales may not be material to the change in our total bookings or revenue compared with prior periods. New product 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). 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 excludes the value associated with perpetual licenses for which revenue is recognized on an up-front basis, 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. Price increases after December 31, 2012 are not considered as part of the renewable value of the prior period contract. We estimate the aggregate renewal 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. 27-------------------------------------------------------------------------------- Table of Contents 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 Condensed 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 Condensed 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. RESULTS OF OPERATIONS The following tables present revenue and expense line items reported in our Condensed Consolidated Statements of Operations for the second quarter and first half of fiscal 2015 and fiscal 2014 and the period-over-period dollar and percentage changes for those line items. These comparisons of past results are not necessarily indicative of future results. Second Quarter Comparison Fiscal 2015 Versus Fiscal 2014 Percentage of Dollar Change Percentage Change Total Revenue 2015 (1) 2014 (1) 2015 / 2014 2015 / 2014 2015 2014 (dollars in millions) Revenue: Subscription and maintenance $ 908 $ 922 $ (14 ) (2 )% 84 % 83 % Professional services 91 97 (6 ) (6 ) 9 9 Software fees and other 80 86 (6 ) (7 ) 7 8 Total revenue $ 1,079 $ 1,105 $ (26 ) (2 )% 100 % 100 % Expenses: Costs of licensing and maintenance $ 71 $ 71 $ - - % 7 % 6 % Cost of professional services 88 88 - - 8 8 Amortization of capitalized software costs 75 69 6 9 7 6 Selling and marketing 253 248 5 2 23 22 General and administrative 87 91 (4 ) (4 ) 8 8 Product development and enhancements 150 142 8 6 14 13 Depreciation and amortization of other intangible assets 34 37 (3 ) (8 ) 3 3 Other expenses, net 1 14 (13 ) (93 ) - 1 Total expenses before interest and income taxes $ 759 $ 760 $ (1 ) - % 70 % 69 % Income from continuing operations before interest and income taxes $ 320 $ 345 $ (25 ) (7 )% 30 % 31 % Interest expense, net 12 13 (1 ) (8 ) 1 1 Income from continuing operations before income taxes $ 308 $ 332 $ (24 ) (7 )% 29 % 30 % Income tax expense 73 101 (28 ) (28 ) 7 9 Income from continuing operations $ 235 $ 231 $ 4 2 % 22 % 21 % 28-------------------------------------------------------------------------------- Table of Contents First Half Comparison Fiscal 2015 Versus Fiscal 2014 Percentage of Dollar Change Percentage Change Total Revenue 2015 (1) 2014 (1) 2015 / 2014 2015 / 2014 2015 2014 (dollars in millions) Revenue: Subscription and maintenance $ 1,817 $ 1,844 $ (27 ) (1 )% 85 % 84 % Professional services 178 195 (17 ) (9 ) 8 9 Software fees and other 153 161 (8 ) (5 ) 7 7 Total revenue $ 2,148 $ 2,200 $ (52 ) (2 )% 100 % 100 % Expenses: Costs of licensing and maintenance $ 143 $ 139 $ 4 3 % 7 % 6 % Cost of professional services 169 176 (7 ) (4 ) 8 8 Amortization of capitalized software costs 142 135 7 5 7 6 Selling and marketing 499 517 (18 ) (3 ) 23 24 General and administrative 179 182 (3 ) (2 ) 8 8 Product development and enhancements 300 274 26 9 14 12 Depreciation and amortization of other intangible assets 68 73 (5 ) (7 ) 3 3 Other expenses, net 15 140 (125 ) (89 ) 1 6 Total expenses before interest and income taxes $ 1,515 $ 1,636 $ (121 ) (7 )% 71 % 74 % Income from continuing operations before interest and income taxes $ 633 $ 564 $ 69 12 % 29 % 26 % Interest expense, net 26 24 2 8 1 1 Income from continuing operations before income taxes $ 607 $ 540 $ 67 12 % 28 % 25 % Income tax expense 160 (21 ) 181 NM 7 (1 ) Income from continuing operations $ 447 $ 561 $ (114 ) (20 )% 21 % 26 % (1) Information presented excludes the results of our discontinued operations. Note: Amounts may not add to their respective totals due to rounding. Revenue Total Revenue As more fully described below, the decrease in total revenue in the second quarter and first half of fiscal 2015 compared with the second quarter and first half of fiscal 2014, respectively, was a result of a decrease in subscription and maintenance revenue, which was primarily due to a decrease in Mainframe Solutions revenue and, to a lesser extent, a decrease in professional services revenue. There was also a favorable foreign exchange effect of $5 million and $10 million for the second quarter and first half of fiscal 2015, respectively. As a result of insufficient revenue from prior period new sales to offset the decline in revenue contribution from renewals, we continue to expect a year-over-year decrease in total revenue for fiscal 2015 compared with fiscal 2014 due to the high percentage of our revenue that is recognized from license agreements with customers signed in prior periods that are being recognized ratably. Excluding the effect of foreign exchange, we currently expect the year-over-year percentage decline in total revenue for fiscal 2015 compared with fiscal 2014 to be similar to the year-over-year percentage decline in total revenue for fiscal 2014 compared with fiscal 2013. 29-------------------------------------------------------------------------------- Table of Contents Subscription and Maintenance 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 the second quarter and first half of fiscal 2015 compared with the second quarter and first half of fiscal 2014, respectively, was primarily attributable to a decrease in Mainframe Solutions revenue (see "Performance of Segments" below). There was also a favorable foreign exchange effect of $5 million and $10 million for the second quarter and first half of fiscal 2015, respectively. Professional Services Professional services revenue primarily includes product implementation, consulting, customer education and customer training. Professional services revenue for the second quarter and first half of fiscal 2015 decreased compared with the second quarter and first half of fiscal 2014, respectively, as a result of a decrease in the size and number of professional services engagements during the first quarter of fiscal 2015, including non-core engagements with government customers that are not directly related to our software product sales. We currently expect the percentage decline in professional services revenue to be greater than the percentage decline in total revenue for fiscal 2015 compared with fiscal 2014. This decline is primarily a result of the decrease in non-core professional services engagements with government customers that are not directly related to our software product sales. We are also refocusing on professional services engagements that drive new product sales. In addition, for the long-term, we expect new versions of our on-premise software to be easier to implement and a higher percentage of our business to shift to a SaaS-based model, which could potentially reduce the demand for our professional services engagements. Software Fees and Other Software fees and other revenue consists primarily 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. Software fees and other revenue decreased for the second quarter of fiscal 2015 compared with the second quarter of fiscal 2014 as a result of a decrease in sales of enterprise solutions products recognized on an up-front basis. The decrease in these sales of enterprise solutions products was primarily due to the increase in the amount of enterprise solutions product sales made in connection with renewal transactions that are recognized ratably within subscription and maintenance revenue. These decreases were partially offset by an increase in revenue from our SaaS offerings. Software fees and other revenue decreased for the first half of fiscal 2015 compared with the first half of fiscal 2014 as a result of a decrease in sales of enterprise solutions products recognized on an up-front basis and a decrease in non re-occurring fees which have been recognized as other revenue. 30-------------------------------------------------------------------------------- Table of Contents Total Revenue by Geography The following tables present the amount of revenue earned from sales to unaffiliated customers in the United States and international regions and corresponding percentage changes for the second quarter and first half of fiscal 2015 and the second quarter and first half of fiscal 2014. Second Quarter Comparison Fiscal 2015 Versus Fiscal 2014 Percentage of Percentage of Dollar Percentage 2015 (1) Total Revenue 2014 (1) Total Revenue Change Change (dollars in millions) United States $ 656 61 % $ 671 61 % $ (15 ) (2 )% International 423 39 434 39 (11 ) (3 ) Total Revenue $ 1,079 100 % $ 1,105 100 % $ (26 ) (2 )% First Half Comparison Fiscal 2015 Versus Fiscal 2014 Percentage of Percentage of Dollar Percentage 2015 (1) Total Revenue 2014 (1) Total Revenue Change Change (dollars in millions) United States $ 1,299 60 % $ 1,328 60 % $ (29 ) (2 )% International 849 40 872 40 (23 ) (3 ) Total Revenue $ 2,148 100 % $ 2,200 100 % $ (52 ) (2 )% (1) Information presented excludes the results of our discontinued operations. Revenue in the United States decreased for the second quarter of fiscal 2015 compared with the second quarter of fiscal 2014 primarily due to a decrease in subscription and maintenance revenue, professional services revenue and software fees and other revenue. International revenue decreased for the second quarter of fiscal 2015 compared with the second quarter of fiscal 2014 primarily due to a decrease in subscription and maintenance revenue. Partially offsetting this decrease was an increase in Europe, Middle East and Africa region new product sales for which revenue is recognized on an up-front basis. Revenue in the United States decreased for the first half of fiscal 2015 compared with the first half of fiscal 2014 primarily due to a decrease in subscription and maintenance revenue, professional services revenue and software fees and other revenue. International revenue decreased for the first half of fiscal 2015 compared with the first half of fiscal 2014 primarily due to a decrease in subscription and maintenance revenue. Price changes do not have a material effect on revenue in a given period as a result of our ratable subscription model. Expenses Operating expenses for the second quarter of fiscal 2015 decreased compared with the second quarter of fiscal 2014 primarily as a result of a decrease in general and administrative expenses and other expenses, net, partially offset by an increase in product development and enhancements expenses and an increase in selling and marketing expenses. For the second quarter of fiscal 2015, operating expenses included an impairment of $13 million relating to capitalized software and other intangible assets within the Enterprise Solutions segment. Operating expenses for the first half of fiscal 2015 decreased compared with the first half of fiscal 2014 primarily as a result of a decrease in costs associated with our Fiscal 2014 Plan. The decrease was also attributable to the timing of selling and marketing expenses and a decrease in personnel-related costs, partially offset by an increase in product development and enhancements expenses. We expect an increase in selling and marketing expenses in the third quarter of fiscal 2015 as a result of expenses associated with CA World '14, which is scheduled to occur in the third quarter of fiscal 2015. 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 in the second quarter of fiscal 2015 were consistent with the second quarter of fiscal 2014. The increase in costs of licensing and maintenance in the first half of fiscal 2015 compared with the first half of fiscal 2014 was primarily attributable to an increase in cost of goods sold related to our SaaS hosting services and the distribution of enterprise solutions products. 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 the second quarter of fiscal 2015 was consistent with the second quarter of fiscal 2014. Cost of professional services for the first half of fiscal 2015 decreased compared with the first half of fiscal 2014. 31-------------------------------------------------------------------------------- Table of Contents Operating margin for professional services decreased to 3% for the second quarter of fiscal 2015 compared with 9% for the second quarter of fiscal 2014. Operating margin for professional services decreased to 5% for the first half of fiscal 2015 compared with 10% for the first half of fiscal 2014. The decrease in operating margin for professional services was attributable to a number of factors, including the decrease in revenue and lower utilization rates for professional services personnel due to the decrease in the number of professional services engagements. Operating margin for professional services does not include certain additional direct costs that are included within the Services segment (see "Performance of Segments" below). Expenses for the Services segment consist of cost of professional services and other direct costs included within selling and marketing and general and administrative expenses. 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. Amortization of capitalized software costs for the second quarter and first half of fiscal 2015 increased compared with the second quarter and first half of fiscal 2014, respectively, as a result of an impairment recorded in the second quarter of fiscal 2015 of $13 million relating to capitalized software and other intangible assets within the Enterprise Solutions segment (see Note E, "Goodwill, Capitalized Software and Other Intangible Assets," in the Notes to the Condensed Consolidated Financial Statements for additional information). This increase was partially offset by a decrease in amortization expense from capitalized software costs that became fully amortized in recent periods. Our product offerings and go-to-market strategy continue to evolve to include solutions and product suites that may be delivered either on-premise or via SaaS or cloud platforms. We expect our product offerings to continue to become available to customers at more frequent intervals than our historical release cycles. We have also adopted the 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. Due to these factors we have commenced capitalization much later in the development life cycle. As a result, product development and enhancements expenses have increased as the amount capitalized for internally developed software costs decreases. We no longer capitalize any significant amounts of internally developed software costs and as a result, future amortization of capitalized software costs is expected to decrease. 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 the second quarter of fiscal 2015, the increase in selling and marketing expenses compared with the second quarter of fiscal 2014 was primarily attributable to a slight increase in commissions resulting from an increase in new sales, as well as an increase in promotion expenses in relation to our marketing efforts. For the first half of fiscal 2015, the decrease in selling and marketing expenses compared with the first half of fiscal 2014 was primarily due to the unfavorable effect of $15 million in expenses associated with CA World '13, our promotional and marketing conference for current and prospective customers, which occurred during the first quarter of fiscal 2014. We expect an increase in selling and marketing expenses in the third quarter of fiscal 2015 as a result of expenses associated with CA World '14, which is scheduled to occur in the third quarter of fiscal 2015. 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. General and administrative expenses decreased for the second quarter and first half of fiscal 2015 compared with the second quarter and first half of fiscal 2014, respectively, primarily due to lower personnel-related expenses. Product Development and Enhancements Product development and enhancements expenses increased in the second quarter of fiscal 2015 compared with the year-ago period primarily due to the decrease in capitalized software development costs in the second quarter of fiscal 2015 of $8 million (see "Amortization of Capitalized Software Costs" above). Product development and enhancements expenses increased in the first half of fiscal 2015 compared with the year-ago period primarily due to the decrease in capitalized software development costs in the first half of fiscal 2015 of $31 million (see "Amortization of Capitalized Software Costs" above), partially offset by a decrease in personnel-related costs from a reduced headcount as a result of the Fiscal 2014 Plan. We currently expect a decrease in capitalized development costs in the second half of fiscal 2015, which will have an unfavorable effect on product development and enhancements expenses for the second half of fiscal 2015, but to a lesser extent than the decrease in capitalized development costs in the first half of fiscal 2015 had on product development and enhancements expenses for the first half of fiscal 2015. 32-------------------------------------------------------------------------------- Table of Contents Depreciation and Amortization of Other Intangible Assets For the second quarter and first half of fiscal 2015, depreciation and amortization expense decreased compared with the second quarter and first half of fiscal 2014, respectively, primarily due to a decrease in property and equipment depreciation expense. Other Expenses, Net The summary of other expenses, net was as follows: Second Quarter Second Quarter Fiscal 2015 Fiscal 2014 (dollars in millions) Fiscal 2014 Plan $ 12 $ 2 Legal settlements 2 6 Losses (gains) from foreign exchange derivative contracts (17 ) (6 ) Losses from foreign exchange rate fluctuations 5 13 Other miscellaneous items (1 ) (1 ) Total $ 1 $ 14 First Half First Half Fiscal 2015 Fiscal 2014 (dollars in millions) Fiscal 2014 Plan $ 21 $ 119 (1) Legal settlements 2 16 Losses (gains) from foreign exchange derivative contracts (12 ) (15 ) Losses from foreign exchange rate fluctuations 5 20 Other miscellaneous items (1 ) - Total $ 15 $ 140 (1) During the first quarter of fiscal 2015, we reclassified $3 million of severance costs for the first quarter of fiscal 2014 to discontinued operations. Refer to Note B, "Divestitures," in the Notes to the Condensed Consolidated Financial Statements for additional information. In fiscal 2014, the Company's Board of Directors approved and committed to the Fiscal 2014 Plan to better align its business priorities. The Company expects total costs of the Fiscal 2014 Plan to be approximately $195 million. The total cumulative amount incurred to date for severance and facility exit costs under the Fiscal 2014 Plan is $192 million. Refer to Note C, "Severance and Exit Costs," in the Notes to the Condensed Consolidated Financial Statements for additional information. Interest Expense, Net Interest expense, net for the second quarter of fiscal 2015 was consistent with the second quarter of fiscal 2014. Interest expense, net for the first half of fiscal 2015 increased compared with the first half of fiscal 2014 as a result of additional interest expense relating to our debt offering that occurred during the second quarter of fiscal 2014. This was partially offset by an increase in interest income from higher cash and cash equivalent balances for the first quarter of fiscal 2015 compared with the first quarter of fiscal 2014. Income Taxes Income tax expense for the second quarter and first half of fiscal 2015 was $73 million and $160 million, respectively, compared with income tax expense of $101 million for the second quarter of fiscal 2014 and an income tax benefit of $21 million for the first half of fiscal 2014. For the second quarter and first half of fiscal 2015, we recognized a discrete tax benefit of $19 million resulting from the resolutions of uncertain tax positions upon the completion of the examination of our U.S. federal income tax returns for the tax years ended March 31, 2011 and 2012. For the first half of fiscal 2014, we recognized a net discrete tax benefit of $179 million, resulting primarily from the resolutions of uncertain tax positions upon the completion of the examination of our U.S. federal income tax returns for the tax years ended March 31, 2005, 2006 and 2007. The examinations of our U.S. federal income tax returns have been concluded through fiscal 2012. Our estimated annual effective tax rate, which excludes the impact of discrete items, for the first half of fiscal 2015 and fiscal 2014 was 29.2% and 29.2%, respectively. Legislative changes in tax laws, the outcome of tax audits and any other changes in potential tax liabilities may result in additional tax expense or benefit in fiscal 2015, which are not considered in our estimated annual effective tax rate. While we do not currently view any such items as individually material to the results of our consolidated financial position or results of operations, the impact of certain items may yield additional tax expense or benefit in the remaining quarters of fiscal 2015 and we are anticipating a fiscal 2015 effective tax rate of approximately 30%. 33-------------------------------------------------------------------------------- Table of Contents Discontinued Operations In the second quarter of fiscal 2015, we sold arcserve for $170 million and recognized a gain on disposal of $19 million, including tax expense of $77 million. In the fourth quarter of fiscal year 2014, we identified our CA ERwin Data Modeling solution assets (ERwin) as available for sale. The results of discontinued operations for the second quarter and first half of fiscal 2015 included revenue of $15 million and $46 million, respectively, and income from operations, net of taxes, of $2 million and $7 million, respectively. The results of discontinued operations for the second quarter and first half of fiscal 2014 included revenue of $35 million and $68 million, respectively, and income from operations, net of taxes, of $9 million and $14 million, respectively. Refer to Note B, "Divestitures," in the Notes to the Condensed 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. The Services segment comprises product implementation, consulting, customer education and customer training, including those directly related to the Mainframe Solutions and Enterprise Solutions software that we sell to our customers. Segment expenses do not include share-based compensation expense; amortization of purchased software; amortization of other intangible assets; certain foreign exchange derivative hedging gains and losses; costs associated with the Fiscal 2014 Plan; and other miscellaneous costs. We consider all costs of internally developed software as segment expenses in the period the costs are incurred, and as a result, we will add back capitalized internal software costs and exclude amortization of internally developed software costs previously capitalized from segment expenses. Segment financial information for the second quarter and first half of fiscal 2015 and fiscal 2014 was as follows: Second Quarter Second Quarter Mainframe Solutions Fiscal 2015 (1) Fiscal 2014 (1) (dollars in millions) Revenue $ 610 $ 624 Expenses 234 232 Segment profit $ 376 $ 392 Segment operating margin 62 % 63 % First Half First Half Mainframe Solutions Fiscal 2015 (1) Fiscal 2014 (1) (dollars in millions) Revenue $ 1,224 $ 1,243 Expenses 469 475 Segment profit $ 755 $ 768 Segment operating margin 62 % 62 % (1) Information presented excludes the results of our discontinued operations. For the second quarter and first half of fiscal 2015, Mainframe Solutions revenue decreased compared with the year-ago period primarily due to insufficient revenue from prior period new sales to offset the decline in revenue contribution from renewals. There was also a favorable foreign exchange effect of $3 million and $6 million for the second quarter and first half of fiscal 2015, respectively. 34-------------------------------------------------------------------------------- Table of Contents Second Quarter Second Quarter Enterprise Solutions Fiscal 2015 (1) Fiscal 2014 (1) (dollars in millions) Revenue $ 378 $ 384 Expenses 327 337 Segment profit $ 51 $ 47 Segment operating margin 13 % 12 % First Half First Half Enterprise Solutions Fiscal 2015 (1) Fiscal 2014 (1) (dollars in millions) Revenue $ 746 $ 762 Expenses 652 688 Segment profit $ 94 $ 74 Segment operating margin 13 % 10 % (1) Information presented excludes the results of our discontinued operations. Enterprise Solutions revenue for the second quarter of fiscal 2015 decreased compared with the year-ago period primarily due to a decrease in revenue that is recognized on an up-front basis in the current period. This decline was primarily due to an increase in the percentage of our Enterprise Solutions new sales sold in connection with renewals compared with the year-ago period. In addition, within Enterprise Solutions there was an unfavorable effect from the decrease in revenue from certain mature product lines, partially offset by an increase in revenue from recently acquired products and sales of newly developed technologies. Enterprise Solutions revenue for the first half of fiscal 2015 decreased compared with the year-ago period primarily due to a decrease in revenue that is recognized on an up-front basis in the current period. This decline was primarily due to an increase in the percentage of our Enterprise Solutions new sales sold in connection with renewals compared with the year-ago period. In addition, within Enterprise Solutions there was an unfavorable effect from the decrease in revenue from certain mature product lines, partially offset by an increase in revenue from recently acquired products and sales of newly developed technologies. Enterprise Solutions operating margin for the first half of fiscal 2015 increased compared with the year-ago period as a result of the timing of selling and marketing expenses and an overall decrease in personnel-related costs. Second Quarter Second Quarter Services Fiscal 2015 Fiscal 2014 (dollars in millions) Revenue $ 91 $ 97 Expenses 89 88 Segment profit $ 2 $ 9 Segment operating margin 2 % 9 % First Half First Half Services Fiscal 2015 Fiscal 2014 (dollars in millions) Revenue $ 178 $ 195 Expenses 171 178 Segment profit $ 7 $ 17 Segment operating margin 4 % 9 % 35 -------------------------------------------------------------------------------- Table of Contents Services revenue for the second quarter and first half of fiscal 2015 decreased compared with the second quarter and first half of fiscal 2014, respectively, primarily as a result of a decrease in the size and number of services engagements during the first quarter of fiscal 2015, including non-core engagements with government customers that are not directly related to our software product sales. We currently expect the percentage decline in services revenue to be greater than the percentage decline in total revenue for fiscal 2015 compared with fiscal 2014. This decline is primarily a result of the decrease in non-core services engagements with government customers that are not directly related to our software product sales. We are also refocusing on services engagements that drive new product sales. In addition, for the long-term, we expect new versions of our on-premise software to be easier to implement and a higher percentage of our business to shift to a SaaS-based model, which could potentially reduce the demand for our services engagements. Operating margin for our Services segment decreased in the second quarter and first half of fiscal 2015 compared with the second quarter and first half of fiscal 2014, respectively, as a result of a number of factors, including the decrease in revenue and lower utilization rates for services personnel due to the decrease in the number of services engagements. Refer to Note O, "Segment Information," in the Notes to the Condensed Consolidated Financial Statements for additional information. Bookings Total Bookings For the second quarter of fiscal 2015 and 2014, total bookings were $749 million and $844 million, respectively. The decrease in bookings was due to an expected year-over-year decrease in renewals within subscription and maintenance bookings, partially offset by an increase in professional services bookings. Total renewals decreased by a percentage in the low twenties primarily due to the timing of our renewals. This timing reflects the decrease in the value of contracts generally available for renewal compared with year-ago period. Total new product sales, a subset of our total bookings, for the second quarter of fiscal 2015 increased by a mid-single-digit percentage compared with the year-ago period. Mainframe Solutions new product sales and capacity growth can be inconsistent on both a quarterly and annual basis. We believe the period-over-period change in mainframe solutions new sales and capacity combined is a more appropriate measure of performance and, therefore, we provide only total mainframe solutions new sales information, which includes mainframe solutions capacity. For the second quarter of fiscal 2015, mainframe solutions new sales declined by a percentage in the low twenties. The decrease in mainframe solutions new sales was primarily due to the timing of our renewals and the composition of the renewal portfolio being more heavily weighted to enterprise solutions renewals in the quarter. Enterprise solutions new product sales increased by a percentage in the low teens as a result of increased sales in our Named customer accounts in all regions and, to a lesser extent, increased sales in our Platinum customer accounts in connection with renewals. This increase was primarily due to increases in sales of our Service Virtualization, API Management and APM products. Total bookings in the second quarter of fiscal 2015 compared with the year-ago period decreased in the Europe, Middle East and Africa and Asia Pacific Japan regions, partially offset by an increase in the United States. The decrease in the Europe, Middle East and Africa and Asia Pacific Japan regions was primarily due to a decrease in the value of contracts generally available for renewal compared with the year-ago period. Total new product sales increased in the United States, offset by decreases in the Europe, Middle East and Africa, Asia Pacific Japan and Latin America regions. For the first half of fiscal 2015 and 2014, total bookings were $1,473 million and $1,640 million, respectively. The decrease in bookings was primarily due to a year-over-year decrease in renewals within subscription and maintenance bookings and professional services bookings. Total renewals decreased from the year-ago period by a percentage in the mid-teens primarily due to the timing of our renewals and the composition of our first half renewal portfolio compared with the year-ago period. Professional services bookings decreased primarily due to a decrease in the size and number of professional services engagements during the first quarter of fiscal 2015, including non-core engagements with government customers that are not directly related to our software product sales. Additionally, professional services bookings in the first quarter of fiscal 2014 were positively affected by several large engagements. Total new product sales, a subset of our total bookings, for the first half of fiscal 2015 increased by a low-single-digit percentage compared with the first half of fiscal 2014. For the first half of fiscal 2015, enterprise solutions new sales increased by a high-single-digit percentage as a result of an increase in sales in our Platinum and Named customer accounts. Sales in our Platinum customer accounts increased in all regions except Latin America. Sales in our Named customer accounts increased in the United States and the Europe, Middle East and Africa region. Currently, we expect enterprise solutions new sales growth for the full year fiscal 2015 to be lower than the enterprise solutions new sales growth we saw in the first half of fiscal 2015 due to an unfavorable second half year-over-year comparison and an increasingly uncertain macro environment. 36-------------------------------------------------------------------------------- Table of Contents For the first half of fiscal 2015, mainframe solutions new sales declined by a percentage in the mid-teens. The decrease in mainframe solutions new sales was primarily due to the composition of the renewal portfolio being more heavily weighted to enterprise solutions renewals. Overall, we expect our mainframe solutions revenue to be flat or decrease by a low-single-digit percentage over the medium term, which we believe is in line with the mainframe market. Total new product sales increased in the United States and Asia Pacific Japan region, offset by a decrease in the Europe, Middle East and Africa and Latin America regions. Total bookings in the first half of fiscal 2015 compared with the year-ago period decreased in all regions except the United States. The decrease in the Europe, Middle East and Africa and Asia Pacific Japan regions was primarily due to the decrease in the value of contracts generally available for renewal compared with the year-ago period. Generally, quarters 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 opportunity for new product sales. Subscription and Maintenance Bookings For the second quarter of fiscal 2015 and fiscal 2014, subscription and maintenance bookings were $571 million and $695 million, respectively. The decrease in subscription and maintenance bookings was primarily attributable to a decrease in our Mainframe Solutions renewals, partially offset by an increase in new product sales that are recognized within subscription and maintenance bookings. During the second quarter of fiscal 2015, we executed a total of six license agreements with incremental contract values in excess of $10 million each, for an aggregate contract value of $217 million. During the second quarter of fiscal 2014, we executed a total of 12 license agreements with incremental contract values in excess of $10 million each, for an aggregate contract value of $320 million. Renewal bookings, as we report them, do not include new product and capacity sales and professional services arrangements. For the second quarter of fiscal 2015 renewal bookings decreased by a percentage in the low-twenties compared with the second quarter of fiscal 2014. Mainframe solutions renewals decreased year-over-year, primarily due to the timing of our renewals and the composition of the renewal portfolio being more heavily weighted to enterprise solutions renewals in the quarter. Renewals can close before their scheduled renewal date for a number of reasons, including customer preference, customer needs for additional products or capacity, or our preference. The level of contracts closed prior to scheduled expiration dates and the reasons for such closings can vary from quarter to quarter. For the second quarter of fiscal 2015, our percentage renewal yield was in the low 90 percent range. We continue to expect the value of our fiscal 2015 renewal portfolio to decline by a high-single-digit percentage compared with fiscal 2014. Excluding the impact from a contract renewal with a large system integrator that occurred during the third quarter of fiscal 2014, we continue to expect the value of our fiscal 2015 renewal portfolio to be consistent with the value of our fiscal 2014 renewal portfolio. For the third quarter of fiscal 2015, we expect the value of our renewal portfolio to decline, while for the fourth quarter of fiscal 2015, we expect it to increase. For the first half of fiscal 2015 and fiscal 2014, subscription and maintenance bookings were $1,174 million and $1,312 million, respectively. The decrease in subscription and maintenance bookings was primarily attributable to a decrease in our Mainframe Solutions renewals, partially offset by an increase in our enterprise solutions renewals and new product sales that are recognized within subscription and maintenance bookings. 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. For the second quarter of fiscal 2015, annualized subscription and maintenance bookings decreased from $209 million in the prior year period to $184 million. The decrease in annualized subscription and maintenance bookings was primarily a result of the lower level of renewal bookings executed during the second quarter of fiscal 2015 compared with the second quarter of 2014. The weighted average subscription and maintenance license agreement duration in years decreased from 3.32 in the second quarter of fiscal 2014 to 3.10 in the second quarter of fiscal 2015. Although each contract is subject to terms negotiated by the respective parties, we do not expect the weighted average subscription and maintenance agreement duration in years to change materially from historical levels for end-user contracts. LIQUIDITY AND CAPITAL RESOURCES Our cash and cash equivalent balances are held in numerous locations throughout the world, with 63% held in our subsidiaries outside the United States at September 30, 2014. Cash and cash equivalents totaled $3,193 million at September 30, 2014, representing a decrease of $59 million from the March 31, 2014 balance of $3,252 million. During the first half of fiscal 2015, there was a $185 million unfavorable translation effect from foreign currency exchange rates on cash held outside the United States in currencies other than the U.S. dollar. 37-------------------------------------------------------------------------------- Table of Contents Although 63% 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 for 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 for capital expenditures, acquisitions and research and development, for at least the next 12 months and for the foreseeable future thereafter. 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 Condensed 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 the second quarter of fiscal 2015, gross receipts related to single installments for the entire contract value, or a substantial portion of the contract value, were $167 million compared with $91 million for the second quarter of fiscal 2014. For the first half of fiscal 2015, gross receipts related to single installments for the entire contract value, or a substantial portion of the contract value, were $235 million compared with $144 million for the first half of fiscal 2014. 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 Condensed 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 Condensed Consolidated Balance Sheets represent the amounts we expect to collect in the future from committed contracts. September 30, March 31, 2014 September 30, (in millions) 2014 (1) (1) 2013 (1) Billings backlog: Amounts to be billed - current $ 1,997 $ 1,983 $ 2,095 Amounts to be billed - noncurrent 2,078 2,365 2,239 Total billings backlog $ 4,075 $ 4,348 $ 4,334 Revenue backlog: Revenue to be recognized within the next 12 months - current $ 3,230 $ 3,500 $ 3,325 Revenue to be recognized beyond the next 12 months - noncurrent 3,581 4,139 3,828 Total revenue backlog $ 6,811 $ 7,639 $ 7,153 Deferred revenue (billed or collected) $ 2,736 $ 3,291 $ 2,819 Total billings backlog 4,075 4,348 4,334 Total revenue backlog $ 6,811 $ 7,639 $ 7,153 (1) Information presented excludes the results of our discontinued operations. Note: Revenue backlog includes deferred subscription and maintenance, professional services and software fees and other 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 Condensed Consolidated Balance Sheets. September 30, March 31, 2014 September 30, (in millions) 2014 (1) (1) 2013 (1) Expected future cash collections: Total billings backlog $ 4,075 $ 4,348 $ 4,334 Trade accounts receivable, net 511 800 588 Total expected future cash collections $ 4,586 $ 5,148 $ 4,922 (1) Information presented excludes the results of our discontinued operations. The decrease in billings backlog at September 30, 2014 compared with September 30, 2013 was primarily a result of the timing of billings from committed contracts that are scheduled to expire prior to fiscal 2016 and to a lesser extent an unfavorable effect of foreign exchange. The decrease in billings backlog at September 30, 2014 compared with March 31, 2014 was primarily a result of the typical higher level of bookings in the fourth quarter of a fiscal year compared with the second quarter of a fiscal year. Excluding the unfavorable effect of foreign exchange, billings backlog would have decreased 4% at September 30, 2014 compared with September 30, 2013 and would have decreased 4% compared with March 31, 2014. The decrease in expected future cash collections at September 30, 2014 compared with September 30, 2013 and March 31, 2014 was primarily driven by the decrease in billings backlog, as described above, and a decrease in trade accounts receivable, net. The decrease in total revenue backlog at September 30, 2014 compared with September 30, 2013 was primarily a result of the unfavorable effect of foreign exchange. The decrease in total revenue backlog at September 30, 2014 compared with March 31, 2014 was primarily a result of the typical higher level of bookings in the fourth quarter of a fiscal year compared with the second quarter of a fiscal year. Excluding the unfavorable effect of foreign exchange, total revenue backlog would have decreased 3% at September 30, 2014 compared with September 30, 2013 and would have decreased 9% compared with March 31, 2014. Revenue to be recognized in the next 12 months decreased 3% at September 30, 2014 compared with September 30, 2013. Excluding the unfavorable effect of foreign exchange, revenue to be recognized in the next 12 months would have decreased 1%. Revenue to be recognized in the next 12 months decreased 8% at September 30, 2014 compared with March 31, 2014. Excluding the unfavorable effect of foreign exchange, revenue to be recognized in the next 12 months would have decreased 6%. These decreases were the results of the factors described above. 39-------------------------------------------------------------------------------- Table of Contents 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. We also believe that we would need to demonstrate multiple quarters of total new product and capacity sales growth while maintaining a renewal yield in the low 90 percent range before growth in the current portion of revenue backlog would be likely to occur. Net Cash Provided by Operating Activities - Continuing Operations Second Quarter of Fiscal Change 2015 (1) 2014 (1) 2015 / 2014 (in millions) Cash collections from billings (2) $ 945 $ 848 $ 97 Vendor disbursements and payroll (2) (704 ) (685 ) (19 ) Income tax payments, net (151 ) (51 ) (100 ) Other disbursements, net (3) (24 ) (39 ) 15 Net cash provided by operating activities - continuing operations $ 66 $ 73 $ (7 ) (1) Information presented excludes the results of our discontinued operations. (2) Amounts include value added taxes and sales taxes. (3) For the second quarter of fiscal 2015, amount includes $16 million of payments associated with the Fiscal 2014 Plan, interest, prior period restructuring plans and miscellaneous receipts and disbursements. For the second quarter of fiscal 2014, amount includes $39 million of payments associated with the Fiscal 2014 Plan, interest, prior period restructuring plans and miscellaneous receipts and disbursements. First Half of Fiscal Change 2015 (1) 2014 (1) 2015 / 2014 (inmillions) Cash collections from billings (2) $ 2,033 $ 1,980 $ 53 Vendor disbursements and payroll (2) (1,537 ) (1,563 ) 26 Income tax payments, net (181 ) (246 ) 65 Other disbursements, net (3) (83 ) (95 ) 12 Net cash provided by operating activities - continuing operations $ 232 $ 76 $ 156 (1) Information presented excludes the results of our discontinued operations. (2) Amounts include value added taxes and sales taxes. (3) For the first half of fiscal 2015, amount includes $46 million of payments associated with the Fiscal 2014 Plan, interest, prior period restructuring plans and miscellaneous receipts and disbursements. For the first half of fiscal 2014, amount includes $59 million of payments associated with the Fiscal 2014 Plan, interest, prior period restructuring plans and miscellaneous receipts and disbursements. Second Quarter Comparison Fiscal 2015 Versus Fiscal 2014 Operating Activities: Net cash provided by operating activities from continuing operations for the second quarter of fiscal 2015 was $66 million, representing a decrease of $7 million compared with the second quarter of fiscal 2014. Net cash provided by operating activities from continuing operations for the second quarter of fiscal 2014 was positively affected by a tax refund of $70 million. Net cash provided by operating activities from continuing operations for the second quarter of fiscal 2015 was positively affected by an increase in cash collections of $97 million. The increase in cash collections was primarily attributable to higher single installment collections of $76 million during the second quarter of fiscal 2015 compared with the second quarter of fiscal 2014. Investing Activities: Net cash used in investing activities from continuing operations for the second quarter of fiscal 2015 was $14 million compared with $44 million for the second quarter of fiscal 2014. The decrease in net cash used in investing activities was primarily due to a decrease in capitalized software development costs of $10 million, a decrease in purchases of property and equipment of $9 million and a decrease in the purchases of short-term investments of $9 million. 40-------------------------------------------------------------------------------- Table of Contents Financing Activities: Net cash used in financing activities from continuing operations for the second quarter of fiscal 2015 was $67 million compared with net cash provided by financing activities from continuing operations of $221 million for the second quarter of fiscal 2014. The change in net financing activities was primarily due to the receipt of proceeds of $498 million from our August 2013 debt offering in the second quarter of fiscal 2014 and a decrease in proceeds from the exercise of common stock options of $25 million, offset by a decrease in common share repurchases of $151 million and an increase in net borrowings from our notional pooling arrangement of $77 million compared with the year-ago period. First Half Comparison Fiscal 2015 Versus Fiscal 2014 Operating Activities: Net cash provided by operating activities from continuing operations for the first half of fiscal 2015 was $232 million, representing an increase of $156 million compared with the first half of fiscal 2014. Net cash provided by operating activities from continuing operations was favorably affected by a decrease in income tax payments of $65 million, a decrease in vendor disbursements and payroll of $26 million and an increase in cash collections of $53 million, which includes an increase in single installment collections of $91 million during the first half of fiscal 2015 compared with the first half of fiscal 2014. In addition, there was a favorable effect of lower cash payments associated with the Fiscal 2014 Plan of $13 million. Investing Activities: Net cash used in investing activities from continuing operations for the first half of fiscal 2015 was $46 million compared with $20 million for the first half of fiscal 2014. The change in net cash used in investing activities was primarily due to the maturities of short-term investments during the first quarter of fiscal 2014 of $184 million, offset by a decrease in cash paid for acquisitions and purchased software of $113 million, a decrease in capitalized software development costs of $35 million and a decrease in the purchase of short-term investments of $9 million. The year-over-year change in our investment amounts is a result of a change in the allocation of our investment portfolio, which reduced our investments in instruments with maturities greater than 90 days. Financing Activities: Net cash used in financing activities from continuing operations for the first half of fiscal 2015 was $207 million compared with net cash provided by financing activities from continuing operations of $83 million for the first half of fiscal 2014. The change in net financing activities was primarily due to the receipt of proceeds of $498 million from our August 2013 debt offering in the second quarter of fiscal 2014 and a decrease in proceeds from the exercise of common stock options of $41 million, offset by a decrease in common share repurchases of $150 million and an increase in net borrowings from our notional pooling arrangement of $86 million compared with the year-ago period. We currently expect to repay our $500 million 6.125% Senior Notes due December 2014 during the third quarter of fiscal 2015. 41-------------------------------------------------------------------------------- Table of Contents Debt Obligations As of September 30, 2014 and March 31, 2014, our debt obligations consisted of the following: September 30, 2014 March 31, 2014 (in millions) Revolving credit facility due June 2018 $ - $ - 5.375% Senior Notes due December 2019 750 750 6.125% Senior Notes due December 2014, net of unamortized premium from fair value hedge of $2 and $8 502 508 2.875% Senior Notes due August 2018 250 250 4.500% Senior Notes due August 2023 250 250 Other indebtedness, primarily capital leases 16 13 Unamortized discount for Notes (5 ) (5 ) Total debt outstanding $ 1,763 $ 1,766 Less the current portion (510 ) (514 ) Total long-term debt portion $ 1,253 $ 1,252 Other Indebtedness We have available an unsecured and uncommitted multi-currency line of credit to meet short-term working capital needs for our subsidiaries operating outside the United States. We use guarantees and letters of credit issued by financial institutions to guarantee performance on certain contracts. At September 30, 2014 and March 31, 2014, $47 million and $49 million, respectively, of this line of credit was pledged in support of bank guarantees and other local credit lines. At September 30, 2014, none of these arrangements were drawn down by third parties. At March 31, 2014, less than $1 million of these arrangements were drawn down by third parties. We use a notional pooling arrangement with an international bank to help manage global liquidity. Under this pooling arrangement, we and our participating subsidiaries may maintain either cash deposit or borrowing positions through local currency accounts with the bank, so long as the aggregate position of the global pool is a notionally calculated net cash deposit. Because it maintains a security interest in the cash deposits and has the right to offset the cash deposits against the borrowings, the bank provides us and our participating subsidiaries favorable interest terms on both. The activity under this cash pooling arrangement for the six months ended September 30, 2014 and 2013 was as follows: Six Months Ended September 30, 2014 2013 (in millions) Total borrowings outstanding at beginning of period (1) $ 139 $ 136 Borrowings 2,703 1,609 Repayments (2,647 ) (1,639 ) Foreign currency exchange effect (56 ) 20 Total borrowings outstanding at end of period (1) $ 139 $ 126 (1) Included in "Accrued expenses and other current liabilities" in our Condensed Consolidated Balance Sheets. For additional information concerning our debt obligations, refer to our Consolidated Financial Statements and Notes thereto included in our 2014 Form 10-K. Effect of Exchange Rate Changes There was a $185 million unfavorable impact to our cash balances in the first half of fiscal 2015 predominantly due to the strengthening of the U.S. dollar against the euro (8%), Israeli shekel (5%), the Australian dollar (6%) and the Brazilian real (7%). There was a $36 million favorable impact to our cash balances in the first half of fiscal 2014 predominantly due to the weakening of the U.S. dollar against the euro (6%) and the British pound sterling (7%), offset by the strengthening of the U.S. dollar against the Australian dollar (11%) and the Brazilian real (9%). 42-------------------------------------------------------------------------------- Table of Contents CRITICAL ACCOUNTING POLICIES AND BUSINESS PRACTICES The preparation of financial statements in accordance with generally accepted accounting principles requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses. We base our estimates on historical experience and various other assumptions that we believe are reasonable under the circumstances. Our estimates form the basis for making judgments about amounts and timing of revenue and expenses, the carrying values of assets and the recorded amounts of liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and the estimates may change if the underlying conditions or assumptions change. Information with respect to our critical accounting policies that we believe could have the most significant effect on our reported results or require subjective or complex judgments by management is contained in our 2014 Form 10-K under Management's Discussion and Analysis of Financial Condition and Results of Operations. At September 30, 2014, there was no material change to this information. New Accounting Pronouncements In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (ASU 2014-09), Revenue from Contracts with Customers (Topic 606), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for annual and interim periods in fiscal years beginning after December 15, 2016. Early application is not permitted. ASU 2014-09 is effective for our first quarter of fiscal year 2018 using either the retrospective or cumulative effect transition method. We are evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures. ASU 2014-09 is expected to have a significant impact on our revenue recognition policies and disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting. |