BMC SOFTWARE INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)


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

For the quarterly period ended September 30, 2004


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

For the transition period from to

Commission file number 001-16393

BMC Software, Inc.

(Exact name of registrant as specified in its charter)


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

2101 CityWest Boulevard
Houston, Texas		77042-2827
(Address of principal executive offices)		(Zip Code)

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]

As of November 3, 2004, there were outstanding 221,953,067 shares of Common Stock, par value $.01, of the registrant.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

BMC SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions)


	March 31,			September 30,
	2004			2004
				(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	612.3		$	479.0
Marketable securities		296.6			166.3
Trade accounts receivable, net		172.6			134.2
Current trade finance receivables, net		175.5			149.8
Other current assets		167.9			145.9

Total current assets		1,424.9			1,075.2
Property and equipment, net		396.0			406.2
Software development costs and related assets, net		138.9			130.8
Long-term marketable securities		304.1			374.0
Long-term trade finance receivables, net		158.7			179.4
Acquired technology, net		80.3			79.7
Goodwill, net		383.6			537.6
Intangible assets, net		56.2			67.7
Other long-term assets		102.1			151.6

	$	3,044.8		$	3,002.2

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Trade accounts payable	$	39.2		$	15.2
Accrued liabilities		279.3			268.3
Current portion of deferred revenue		668.4			689.6

Total current liabilities		986.9			973.1
Long-term deferred revenue		733.2			717.8
Other long-term liabilities		109.5			92.9

Total liabilities		1,829.6			1,783.8
Commitments and contingencies
Stockholders’ equity:
Preferred stock		—			—
Common stock		2.5			2.5
Additional paid-in capital		537.2			557.1
Retained earnings		1,108.8			1,126.6
Accumulated other comprehensive income (loss)		(10.7	)		(13.4	)

		1,637.8			1,672.8
Less treasury stock, at cost		(421.7	)		(443.3	)
Less unearned portion of stock-based compensation		(0.9	)		(11.1	)

Total stockholders’ equity		1,215.2			1,218.4

	$	3,044.8		$	3,002.2

The accompanying notes are an integral part of these condensed consolidated financial statements.

BMC SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(In millions, except per share data)
(Unaudited)


	Three Months Ended						Six Months Ended
	September 30,						September 30,
	2003			2004			2003			2004
Revenues:
License	$	124.7		$	132.5		$	232.3		$	232.8
Maintenance		188.2			199.9			371.7			404.7
Professional services		20.9			22.7			39.7			43.6

Total revenues		333.8			355.1			643.7			681.1

Operating expenses:
Selling and marketing expenses		140.2			131.2			278.1			255.9
Research, development and support expenses		147.1			117.7			274.4			227.0
Cost of professional services		20.0			23.2			39.0			43.7
General and administrative expenses		47.9			49.9			85.2			92.6
Settlement of litigation		—			11.3			—			11.3
Amortization of acquired technology and intangibles		15.3			19.4			30.9			35.5
Acquired research and development		—			0.2			—			0.2

Total operating expenses		370.5			352.9			707.6			666.2

Operating income (loss)		(36.7	)		2.2			(63.9	)		14.9
Interest and other income, net		16.7			16.4			38.4			36.1
Gain (loss) on marketable securities and other investments		1.1			(0.7	)		0.2			(2.8	)

Other income, net		17.8			15.7			38.6			33.3

Earnings (loss) before income taxes		(18.9	)		17.9			(25.3	)		48.2
Income tax provision (benefit)		(5.7	)		5.2			(6.0	)		24.8

Net earnings (loss)	$	(13.2	)	$	12.7		$	(19.3	)	$	23.4

Basic earnings (loss) per share	$	(0.06	)	$	0.06		$	(0.08	)	$	0.11

Diluted earnings (loss) per share	$	(0.06	)	$	0.06		$	(0.08	)	$	0.10

Shares used in computing basic earnings (loss) per share		227.1			222.6			228.3			222.8

Shares used in computing diluted earnings (loss) per share		227.1			223.9			228.3			224.5

Comprehensive income (loss):
Net earnings (loss)	$	(13.2	)	$	12.7		$	(19.3	)	$	23.4
Foreign currency translation adjustment		(5.5	)		2.4			7.4			2.0
Unrealized gain (loss) on securities available for sale:
Unrealized gain (loss), net of taxes of $1.9, $0.6, $0.9 and $3.4		(3.5	)		1.1			(1.7	)		(6.4	)
Realized (gain) loss included in net earnings (loss), net of taxes of $0.4, $0.1, $0.1 and $0.6		(0.7	)		(0.2	)		(0.1	)		1.2

		(4.2	)		0.9			(1.8	)		(5.2	)
Unrealized gain (loss) on derivative instruments:
Unrealized gain (loss), net of taxes of $0.2, $0.3, $1.1 and $0.3		(0.4	)		(0.6	)		(2.1	)		(0.6	)
Realized (gain) loss included in net earnings (loss), net of taxes of $0.4, $0.4, $0.7 and $0.5		0.7			0.8			1.3			1.1

		0.3			0.2			(0.8	)		0.5

Comprehensive income (loss)	$	(22.6	)	$	16.2		$	(14.5	)	$	20.7

The accompanying notes are an integral part of these condensed consolidated financial statements.

BMC SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)


	Six Months Ended
	September 30,
	2003			2004
Cash flows from operating activities:
Net earnings (loss)	$	(19.3	)	$	23.4
Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities:
Acquired research and development		—			0.2
Depreciation and amortization		134.7			102.5
Impairment of investments		—			1.0
(Gain) loss on marketable securities		(0.2	)		1.8
Earned portion of stock-based compensation		1.0			1.4
(Increase) decrease in finance receivables		105.0			1.7
Increase (decrease) in payables to third-party financing institutions for finance receivables		(34.2	)		(25.4	)
Increase (decrease) in accrued exit costs		9.1			(17.0	)
Net change in trade receivables, payables, deferred revenue and other components of working capital		(38.0	)		10.5

Net cash provided by (used in) operating activities		158.1			100.1

Cash flows from investing activities:
Cash paid for technology acquisitions and other investments, net of cash acquired		(6.7	)		(212.0	)
Adjustment of cash paid for Remedy acquisition		7.2			—
Return of capital for cost-basis investments		0.1			0.7
Proceeds from sale of technology		2.0			—
Proceeds from sale of financial instruments and other		—			4.5
Purchases of marketable securities		(267.2	)		(115.5	)
Proceeds from maturities/sales of marketable securities		130.2			187.0
Purchases of property and equipment		(22.9	)		(34.4	)
Capitalization of software development costs and related assets		(31.8	)		(29.6	)

Net cash provided by (used in) investing activities		(189.1	)		(199.3	)

Cash flows from financing activities:
Payments on capital leases		—			(2.3	)
Stock options exercised and other		9.0			13.4
Treasury stock acquired		(90.0	)		(45.0	)

Net cash provided by (used in) financing activities		(81.0	)		(33.9	)

Effect of exchange rate changes on cash		3.3			(0.2	)

Net change in cash and cash equivalents		(108.7	)		(133.3	)
Cash and cash equivalents, beginning of period		500.1			612.3

Cash and cash equivalents, end of period	$	391.4		$	479.0

Supplemental disclosure of cash flow information:
Cash paid (refunded) for income taxes	$	0.9		$	10.1
Cash paid for interest	$	—		$	0.6
Capital lease obligation for computer hardware	$	16.7		$	4.2
Stock options issued and liabilities assumed in acquisitions	$	0.2		$	35.3

The accompanying notes are an integral part of these condensed consolidated financial statements.

BMC SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) Basis of Presentation

The accompanying condensed consolidated financial statements include the accounts of BMC Software, Inc. and its majority-owned subsidiaries (collectively, the Company or BMC). All significant intercompany balances and transactions have been eliminated in consolidation.

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

These financial statements should be read in conjunction with the Company’s audited financial statements for the year ended March 31, 2004, as filed with the Securities and Exchange Commission on Form 10-K.

(2) Earnings (Loss) Per Share

Basic earnings per share (EPS) is computed by dividing net earnings (loss) by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. For purposes of this calculation, outstanding stock options and unearned restricted stock are considered potential common shares using the treasury stock method. For the three-month periods ended September 30, 2003 and 2004, the treasury stock method effect of 34.2 million and 29.1 million weighted options, respectively, has been excluded from the calculation of diluted EPS, as they are anti-dilutive. For the six-month periods ended September 30, 2003 and 2004, the treasury stock method effect of 30.4 million and 24.4 million weighted options, respectively, has been excluded from the calculation of diluted EPS, as they are anti-dilutive. The following table summarizes the basic and diluted EPS computations for the three months and six months ended September 30, 2003 and 2004:


	Three Months Ended					Six Months Ended
	September 30,					September 30,
	2003			2004		2003			2004
	(In millions, except per share data)
Basic earnings (loss) per share:
Net earnings (loss)	$	(13.2	)	$	12.7	$	(19.3	)	$	23.4
Weighted average number of common shares		227.1			222.6		228.3			222.8

Basic earnings (loss) per share	$	(0.06	)	$	0.06	$	(0.08	)	$	0.11

Diluted earnings (loss) per share:
Net earnings (loss)	$	(13.2	)	$	12.7	$	(19.3	)	$	23.4

Weighted average number of common shares		227.1			222.6		228.3			222.8
Incremental shares from assumed conversions of stock options and other		—			1.3		—			1.7

Adjusted weighted average number of common shares		227.1			223.9		228.3			224.5

Diluted earnings (loss) per share	$	(0.06	)	$	0.06	$	(0.08	)	$	0.10

(3) Business Combinations

On July 15, 2004, the Company acquired all of the outstanding shares of Marimba, Inc. (Marimba) for cash of $230.3 million and exchanged 2.3 million BMC common stock options with a fair value of $21.1 million for all of Marimba’s outstanding options. The fair value of the options issued is included in the aggregate purchase price for the acquisition and was determined using the Black-Scholes option pricing model and the average market price of the Company’s common shares over the five-day period up to and including the closing date of the acquisition. The $8.3 million portion of the intrinsic value of unvested options issued that will be earned over the remaining vesting periods of those options has been allocated to unearned compensation cost and will be recognized as compensation expense over the remaining vesting periods of the options.

Marimba’s results have been included in the Company’s Condensed Consolidated Financial Statements since the acquisition date as part of the Service Management segment. Marimba focuses on IT asset discovery and asset, change and configuration management, which will strengthen the Company’s Business Service Management (BSM)-related offerings.

The aggregate purchase price was $255.5 million, including direct costs of the transaction. The allocation of the purchase price to specific assets and liabilities was based, in part, upon outside appraisals of the fair value of certain assets and liabilities of Marimba. This allocation is preliminary and is subject to refinement. The following table summarizes the estimated fair values of the assets and liabilities recorded at the date of acquisition.


	July 15,
	2004
	(In millions)
Cash and short-term marketable securities	$	38.1
Other current assets		12.3
Long-term marketable securities		15.2
Property and equipment and other long-term assets		17.2
Intangible assets		40.2
Goodwill		152.6

Total assets acquired		275.6

Current liabilities		(14.5	)
Long-term liabilities		(13.9	)

Total liabilities		(28.4	)

Unearned compensation cost		8.3

Net assets acquired	$	255.5

Of the $40.2 million of acquired intangible assets, $38.4 million of those assets have an estimated weighted-average useful life of three and one half years, and include $20.0 million of acquired technology with an estimated weighted-average economic life of three years and $18.4 million of customer relationships with an estimated weighted-average useful life of four years. The estimated fair value of acquired technology, which consists of products that have reached technological feasibility, primarily relates to Marimba’s Report Center and Application Management products and the infrastructure over which all Marimba products are developed. Customer relationships represent the benefit to be derived from Marimba’s existing license, maintenance and professional services customer base. In addition, $1.8 million was assigned to tradenames that are not subject to amortization, primarily related to the estimated fair value of the Marimba name. Tradenames will not be amortized because the assets have indefinite remaining useful lives but will be reviewed periodically for impairment. At the acquisition date, there were no projects that had progressed to a degree that would enable the fair value of the in-process research and development (IPR&D) to be estimated with reasonable reliability, and therefore, no value was allocated to IPR&D.

The $152.6 million of goodwill was assigned to the Service Management segment and none of that amount is expected to be deductible for tax purposes. Factors that contributed to a purchase price that results in goodwill include, but are not limited to, the retention of research and development personnel with the skills to develop future Marimba technology, support personnel to provide the maintenance services related to Marimba products and a trained sales force capable of selling current and future Marimba products, the opportunity to cross-sell Marimba and BMC products to existing customers and the positive reputation that Marimba has in the market.

The following unaudited pro forma results of operations for the three months and six months ended September 30, 2003 and 2004, are as if the acquisition of Marimba had occurred at the beginning of each period presented. The unaudited pro forma financial information includes material non-recurring charges of $34.4 million related to exit activities for the three months and six months ended September 30, 2003. The pro forma consolidated results do not purport to be indicative of results that would have occurred had the acquisition been in effect for the periods presented, nor do they purport to be indicative of the results that will be obtained in the future.


	Three Months Ended					Six Months Ended
	September 30,					September 30,
	2003			2004		2003			2004
	(In millions, except per share data)
Revenues	$	343.6		$	355.1	$	663.7		$	692.9
Net earnings (loss)	$	(16.0	)	$	12.7	$	(24.9	)	$	21.1
Basic EPS	$	(0.07	)	$	0.06	$	(0.11	)	$	0.09
Diluted EPS	$	(0.07	)	$	0.06	$	(0.11	)	$	0.09

The Company also completed the acquisition of Viadyne Corporation (Viadyne) during the three months ended September 30, 2004. The aggregate purchase price for this transaction was $5.7 million in cash, and was allocated as follows: $2.6 million to acquired technology, $0.2 million to acquired research and development, $1.1 million to other intangibles and $1.8 million to tangible assets acquired, net of liabilities assumed.

(4) Segment Reporting

Effective April 1, 2004, BMC’s management reviews the results of the Company’s software business by the following product categories: Mainframe Management, including the Mainframe Data Management and MAINVIEW® product lines; Distributed Systems Management, which includes the PATROL®, Distributed Systems Data Management and Scheduling & Output Management product lines; Service Management; and Identity Management. In addition to these software segments, Professional Services is also considered a separate segment. The software segments above reflect management’s recategorization of certain products to clarify accountability and increase organizational effectiveness. The amounts reported below for the three months and six months ended September 30, 2003 and 2004, reflect these changes in the composition of the Company’s business segments.

For the Mainframe Management, Distributed Systems Management, Service Management and Professional Services segments, segment performance is measured based on contribution margin, reflecting only the direct controllable expenses of the segments. Segment performance for the Identity Management segment is measured based on its direct controllable research and development (R&D) costs and the costs of the dedicated Identity Management sales and services team in North America. As such, management’s measure of profitability for these segments does not include allocation of indirect research and development and support expenses, the effect of software development cost capitalization and amortization, selling and marketing expenses other than for North America Identity Management, general and administrative expenses, amortization of acquired technology and intangibles, one-time charges, other income, net, and income taxes. The indirect portion of R&D and support expenses, cost of professional services and selling and marketing expenses includes costs associated with the exit activities described in footnote 6, as these exit costs are not included in the measurement of segment performance. Assets and liabilities are not accounted for by segment.


	Software
	Mainframe		Distributed Systems		Service		Identity					Professional		Indirect
	Management		Management		Management		Management			Other		Services		Costs			Consolidated
	(In millions)
Quarter Ended September 30, 2003
Revenues:
License	$	45.3	$	54.2	$	23.1	$	1.9		$	0.2	$	—	$	—		$	124.7
Maintenance		76.8		72.9		34.1		4.4			—		—		—			188.2
Professional services		—		—		—		0.8			—		20.1		—			20.9

Total revenues		122.1		127.1		57.2		7.1			0.2		20.1		—			333.8
R&D and support expenses		22.1		45.7		13.2		7.0			—		—		59.1			147.1
Cost of professional services		—		—		—		0.8			—		17.0		2.2			20.0

		100.0		81.4		44.0		(0.7	)		0.2		3.1		(61.3	)		166.7
Selling and marketing expenses		—		—		—		2.8			—		—		137.4			140.2

Contribution margin	$	100.0	$	81.4	$	44.0	$	(3.5	)	$	0.2	$	3.1	$	(198.7	)		26.5

General and administrative expenses																		47.9
Amortization of acquired technology and intangibles																		15.3
Other income, net																		17.8

Consolidated earnings (loss) before income taxes																	$	(18.9	)


	Software
	Mainframe		Distributed Systems		Service		Identity					Professional			Indirect
	Management		Management		Management		Management			Other		Services			Costs			Consolidated
	(In millions)
Quarter Ended September 30, 2004
Revenues:
License	$	46.0	$	46.7	$	38.7	$	1.1		$	—	$	—		$	—		$	132.5
Maintenance		73.4		74.0		48.6		3.9			—		—			—			199.9
Professional services		—		—		—		0.4			—		22.3			—			22.7

Total revenues		119.4		120.7		87.3		5.4			—		22.3			—			355.1
R&D and support expenses		21.9		40.6		20.8		5.9			—		—			28.5			117.7
Cost of professional services		—		—		—		0.5			—		22.7			—			23.2

		97.5		80.1		66.5		(1.0	)		—		(0.4	)		(28.5	)		214.2
Selling and marketing expenses		—		—		—		2.1			—		—			129.1			131.2

Contribution margin	$	97.5	$	80.1	$	66.5	$	(3.1	)	$	—	$	(0.4	)	$	(157.6	)		83.0

General and administrative expenses																			49.9
Settlement of litigation																			11.3
Amortization of acquired technology and intangibles																			19.4
Acquired research and development																			0.2
Other income, net																			15.7

Consolidated earnings (loss) before income taxes																		$	17.9


	Software
	Mainframe		Distributed Systems		Service		Identity					Professional		Indirect
	Management		Management		Management		Management			Other		Services		Costs			Consolidated
	(In millions)
Six Months Ended September 30, 2003
Revenues:
License	$	80.9	$	101.9	$	43.9	$	5.3		$	0.3	$	—	$	—		$	232.3
Maintenance		155.0		143.6		63.9		8.6			0.6		—		—			371.7
Professional services		—		—		—		1.1			—		38.6		—			39.7

Total revenues		235.9		245.5		107.8		15.0			0.9		38.6		—			643.7
R&D and support expenses		43.1		93.5		27.3		14.5			—		—		96.0			274.4
Cost of professional services		—		—		—		1.8			—		35.0		2.2			39.0

		192.8		152.0		80.5		(1.3	)		0.9		3.6		(98.2	)		330.3
Selling and marketing expenses		—		—		—		5.5			—		—		272.6			278.1

Contribution margin	$	192.8	$	152.0	$	80.5	$	(6.8	)	$	0.9	$	3.6	$	(370.8	)		52.2

General and administrative expenses																		85.2
Amortization of acquired technology and intangibles																		30.9
Other income, net																		38.6

Consolidated earnings (loss) before income taxes																	$	(25.3	)


	Software
	Mainframe		Distributed Systems		Service		Identity					Professional		Indirect
	Management		Management		Management		Management			Other		Services		Costs			Consolidated
	(In millions)
Six Months Ended September 30, 2004
Revenues:
License	$	80.7	$	82.7	$	66.9	$	2.5		$	—	$	—	$	—		$	232.8
Maintenance		151.1		151.3		94.7		7.6			—		—		—			404.7
Professional services		—		—		—		0.7			—		42.9		—			43.6

Total revenues		231.8		234.0		161.6		10.8			—		42.9		—			681.1
R&D and support expenses		43.7		79.6		36.8		11.9			—		—		55.0			227.0
Cost of professional services		—		—		—		1.0			—		42.7		—			43.7

		188.1		154.4		124.8		(2.1	)		—		0.2		(55.0	)		410.4
Selling and marketing expenses		—		—		—		4.5			—		—		251.4			255.9

Contribution margin	$	188.1	$	154.4	$	124.8	$	(6.6	)	$	—	$	0.2	$	(306.4	)		154.5

General and administrative expenses																		92.6
Settlement of litigation																		11.3
Amortization of acquired technology and intangibles																		35.5
Acquired research and development																		0.2
Other income, net																		33.3

Consolidated earnings (loss) before income taxes																	$	48.2

(5) Stock Incentive Plans

The Company has numerous stock plans that provide for the grant of common stock options and restricted stock to employees and directors of the Company. Under the option plans, all options have been granted at fair market value as of the date of grant and have a ten-year term, except for the 2.1 million replacement stock options issued below fair market value and 0.2 million replacement stock options issued above fair market value during the three months ended September 30, 2004 as consideration in the Marimba acquisition. The purchase price for this acquisition includes $21.1 million related to the replacement options issued, of which $8.3 million was allocated to unearned portion of stock-based compensation, reflecting the portion of the intrinsic value of the 1.2 million unvested options issued that will be earned over the remaining vesting periods of those options. This amount will be recognized as compensation expense over the remaining vesting periods of the options. The restricted stock issued under the Company’s stock plans is subject to transfer restrictions that lapse over one to four years. The Company also has an employee stock purchase plan (ESPP) under which rights to purchase the Company’s common stock are granted at 85% of the lesser of the market value of the common stock at the offering date or on the exercise date.

The Company accounts for stock-based employee compensation using the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25 and related interpretations, which generally requires that the amount of compensation cost that must be recognized, if any, is the quoted market price of the stock at the measurement date, which is generally the grant date, less the amount the grantee is required to pay to acquire the stock. Alternatively, Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation,” employs fair value-based measurement and generally results in the recognition of compensation expense for all stock-based awards to employees. SFAS No. 123 does not require an entity to adopt those provisions, but rather, permits continued application of APB Opinion No. 25. The Company has elected not to adopt the recognition and measurement provisions of SFAS No. 123 and continues to account for its stock-based employee compensation plans under APB Opinion No. 25 and related interpretations. In accordance with APB Opinion No. 25, deferred compensation is generally recorded for stock-based employee compensation grants based on the excess of the market value of the common stock on the measurement date over the exercise price. The deferred compensation is amortized to expense over the vesting period of each unit of stock-based employee compensation granted. If the exercise price of the stock-based compensation is equal to or exceeds the market price of the Company’s common stock on the date of grant, no compensation expense is recorded.

For the three months ended September 30, 2003 and 2004, the Company recorded compensation expense of $0.4 million and $0.3 million, respectively, for restricted stock grants. For the six months ended September 30, 2003 and 2004, the Company recorded compensation expense of $1.0 million and $0.6 million, respectively, for restricted stock grants. The Company was not required to record compensation expense for stock option grants and stock issued under the ESPP during the same periods, except for the unvested replacement options issued as consideration in the Marimba acquisition. For the three months and six months ended September 30, 2004, the Company recorded compensation expense of $0.8 million related to these options.

The compensation expense recorded for restricted stock grants under the intrinsic value method is consistent with the expense that would be recorded under the fair value-based method. Had the compensation cost for the Company’s employee stock option grants and stock issued under the ESPP been determined based on the grant date fair values of awards estimated using the Black-Scholes option pricing model, which is consistent with the method described in SFAS No. 123, the Company’s reported net earnings (loss) and earnings (loss) per share would have been reduced to the following pro forma amounts:


		Three Months Ended		Six Months Ended
		September 30,		September 30,
		2003	2004	2003	2004
		(In millions, except per share data)
Net earnings (loss):	As Reported	$(13.2)	$12.7	$(19.3)	$23.4
Add stock-based employee compensation expense included in net earnings (loss) as reported (in millions) of $0.4, $1.1, $1.0 and $1.4, net of related tax effects		0.3	0.7	0.7	0.9
Deduct stock-based employee compensation expense determined under the fair value-based method for all awards, net of related tax effects		(18.4)	(25.4)	(44.3)	(47.9)

	Pro Forma	$(31.3)	$(12.0)	$(62.9)	$(23.6)
Basic earnings (loss) per share:	As Reported	$(0.06)	$0.06	$(0.08)	$0.11
	Pro Forma	$(0.14)	$(0.05)	$(0.28)	$(0.11)
Diluted earnings (loss) per share:	As Reported	$(0.06)	$0.06	$(0.08)	$0.10
	Pro Forma	$(0.14)	$(0.05)	$(0.28)	$(0.11)

(6) Exit Activities and Related Costs

During the year ended March 31, 2004, the Company achieved a better alignment of its cost structure with market conditions. The Company’s actions included the involuntary termination of approximately 785 employees during the three months ended September 30, 2003. The Company also exited leases in certain locations, reduced the square footage required to operate some locations and relocated some operations to lower cost facilities. These relocation efforts were completed as of December 31, 2003. The expenses related to the exit activities for the three months and six months ended September 30, 2003 are reflected in the accompanying Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) as follows:


	Severance & Related				Incremental
	Costs		Facilities		Depreciation		Total
	(In millions)
Selling and marketing expenses	$	14.2	$	0.7	$	3.4	$	18.3
Research, development and support expenses		8.7		—		2.8		11.5
Cost of professional services		2.2		—		—		2.2
General and administrative expenses		1.8		—		0.6		2.4

Total included in operating expenses	$	26.9	$	0.7	$	6.8	$	34.4

As of September 30, 2004, $51.6 million of severance and facilities costs related to actions completed under the plan remained accrued for payment in future periods, as follows:


											Balance at
	Balance at				Adjustments			Cash Payments Net			September 30,
	March 31, 2004		Accretion		to Estimates			of Sublease Income			2004
	(In millions)
Severance and related costs	$	3.9	$	—	$	0.1		$	(2.8	)	$	1.2
Facilities costs		64.7		0.9		(1.3	)		(13.9	)		50.4

Total accrual	$	68.6	$	0.9	$	(1.2	)	$	(16.7	)	$	51.6

The amounts accrued at September 30, 2004 related to facilities costs represent the remaining fair value of lease obligations related to exited locations, as determined at the cease-use dates of those facilities, net of estimated sublease income that could be reasonably obtained in the future, and will be paid out over the remaining lease terms, the last of which ends in fiscal 2011. The Company does not expect any significant additional severance or facilities charges subsequent to September 30, 2004 other than potential adjustments to lease accruals based on actual subleases differing from estimates. The Company expects that the vast majority of the severance and related costs will be paid by the end of fiscal 2005. Accretion (the increase in the present value of facilities accruals over time) and adjustments to original estimates are included in operating expenses.

(7) Income Taxes

The income tax provision (benefit) for the three months and six months ended September 30, 2004 is $5.2 million and $24.8 million, respectively, resulting in effective tax rates of 29% and 51%, respectively. The income tax provision (benefit) for the six months ended September 30, 2004 includes additional income tax provisions of approximately $11.1 million recorded in the quarter ended June 30, 2004, intended to satisfy income tax assessments that may result from the examination of the Company’s corporate income tax returns that have been filed in domestic and foreign jurisdictions and to increase the valuation allowance for certain deferred tax assets.

(8) Settlement of Litigation

Subsequent to September 30, 2004, the Company reached an agreement in principle with Nastel Technologies, Inc. (Nastel) for a no-fault settlement whereby BMC will pay Nastel $11.3 million. In July 2001, Nastel filed a complaint against the Company alleging among other claims that Boole and Babbage, a company that BMC acquired in 1999, had exceeded license rights of software prior to its acquisition by BMC, and that BMC then stopped marketing certain products in 1999. The settlement payment covers all claims involved in this action, is expected to be made during the three months ending December 31, 2004, and is reflected as settlement of litigation in the accompanying Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three months and six months ended September 30, 2004.

ITEM 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition

This section of the Report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are identified by the use of the words “believe,” “expect,” “anticipate,” “will,” “contemplate,” “would” and similar expressions that contemplate future events. Numerous important factors, risks and uncertainties affect our operating results, including, without limitation, those contained in this Report, and could cause our actual results to differ materially from the results implied by these or any other forward-looking statements made by us or on our behalf. There can be no assurance that future results will meet expectations. You should pay particular attention to the important risk factors and cautionary statements described in the section of this Report entitled “Certain Risks and Uncertainties.” It is important that the historical discussion below be read together with the attached condensed consolidated financial statements and notes thereto, with the discussion of such risks and uncertainties and with the audited financial statements and notes thereto, and Management’s Discussion and Analysis of Results of Operations and Financial Condition contained in our Annual Report on Form 10-K for fiscal 2004.

Overview

We market software solutions designed to improve the availability, performance and recoverability of enterprise applications, databases and other IT systems components operating in mainframe, distributed computing and Internet environments. Our Service Management product category extends our solutions to include products that automate service-related business processes through a complete suite of service management applications. Our strategy is focused on Business Service Management (BSM), the direct linkage of IT resources, management and solutions with the goals of the overall business. The objective of our BSM strategy is to enable companies to move beyond traditional IT management and manage their business-critical services from both an IT and business perspective.

For the quarter and six months ended September 30, 2004, our diluted earnings per share were $0.06 and $0.10 per share, respectively, as compared to diluted losses of $0.06 and $0.08 per share, respectively, for the same periods in the prior year. This improvement is primarily related to decreased operating expenses during the periods as a result of our restructuring activities in the prior year and increased license and maintenance revenues during the quarter ended September 30, 2004. Our license revenues during the quarter increased 6% compared to the same period of fiscal 2004, while license revenues for the six months ended September 30, 2004 were flat. We maintained a strong balance sheet with cash, cash equivalents and marketable securities balances at September 30, 2004 of $1.0 billion, and we generated $100.1 million in cash flows from operations for the six months ended September 30, 2004.

Industry Conditions

We believe that buyers of systems management software are now more focused on linking their IT operations and infrastructure with their overall business services. We remain optimistic about our business prospects and continue to believe that we are uniquely positioned to be the leading provider of BSM solutions; nevertheless, we recognize that the systems management software marketplace is highly competitive. We compete with a variety of software vendors, including large vendors such as IBM, HP, Computer Associates and a number of other smaller software vendors. We compete for new customers and, from time to time, must compete to maintain our relationships with our current customers. This competition can lead to pricing pressure and can affect our margins. We discuss competition in greater detail in the “Certain Risks and Uncertainties” section of Management’s Discussion and Analysis of Results of Operations and Financial Condition.

Critical Accounting Policies

The preparation of condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we make and evaluate estimates and judgments, including those related to revenue recognition, capitalized software development costs, valuation of investments and accounting for income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about amounts and timing of revenues 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 such estimates may change if the underlying conditions or assumptions change. We have discussed the development and selection of the critical accounting policies with the Audit Committee of our Board of Directors, and the Audit Committee has reviewed our related disclosures. The critical accounting policies related to the estimates and judgments listed above are discussed further in our Annual Report on Form 10-K for fiscal 2004 under Management’s Discussion and Analysis of Results of Operations and Financial Condition. Our critical accounting polices have not changed in any material respect, nor have we adopted any new critical accounting policies during the six months ended September 30, 2004.

Results of Operations and Financial Condition

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


	Percentage of Total Revenues
	Three Months Ended						Six Months Ended
	September 30,						September 30,
	2003			2004			2003			2004
Revenues:
License		37.3	%		37.3	%		36.1	%		34.2	%
Maintenance		56.4			56.3			57.7			59.4
Professional services		6.3			6.4			6.2			6.4

Total revenues		100.0			100.0			100.0			100.0

Selling and marketing expenses		42.0			36.9			43.2			37.6
Research, development and support expenses		44.1			33.2			42.6			33.3
Cost of professional services		6.0			6.5			6.1			6.4
General and administrative expenses		14.3			14.1			13.2			13.6
Settlement of litigation		—			3.2			—			1.7
Amortization of acquired technology and intangibles		4.6			5.5			4.8			5.2
Acquired research and development		—			—			—			—

Total operating expenses		111.0			99.4			109.9			97.8

Operating income (loss)		(11.0	)		0.6			(9.9	)		2.2
Interest and other income, net		5.0			4.6			6.0			5.3
Gain (loss) on marketable securities and other investments		0.3			(0.2	)		—			(0.4	)

Other income, net		5.3			4.4			6.0			4.9
Earnings (loss) before income taxes		(5.7	)		5.0			(3.9	)		7.1
Income tax provision (benefit)		(1.7	)		1.4			(0.9	)		3.7

Net earnings (loss)		(4.0	)%		3.6	%		(3.0	)%		3.4	%

Revenues

We generate revenues from licensing software, providing maintenance, enhancement and support for previously licensed products and providing professional services.


	Three Months Ended							Six Months Ended
	September 30,							September 30,
	2003		2004		Change			2003		2004		Change
	(In millions)							(In millions)
License:
Domestic	$	57.2	$	61.6		7.7	%	$	100.6	$	108.0		7.4	%
International		67.5		70.9		5.0	%		131.7		124.8		(5.2	)%

Total license revenues		124.7		132.5		6.3	%		232.3		232.8		0.2	%
Maintenance:
Domestic		106.4		111.8		5.1	%		212.1		226.8		6.9	%
International		81.8		88.1		7.7	%		159.6		177.9		11.5	%

Total maintenance revenues		188.2		199.9		6.2	%		371.7		404.7		8.9	%
Professional services:
Domestic		11.3		10.1		(10.6	)%		20.4		20.1		(1.5	)%
International		9.6		12.6		31.3	%		19.3		23.5		21.8	%

Total professional services revenues		20.9		22.7		8.6	%		39.7		43.6		9.8	%

Total revenues	$	333.8	$	355.1		6.4	%	$	643.7	$	681.1		5.8	%

Product License Revenues

Our product license revenues primarily consist of fees related to products licensed to customers on a perpetual basis. Product license fees can be associated with a customer’s licensing of a given software product for the first time or with a customer’s purchase of the right to run a previously licensed product on additional computing capacity or to add users. Our license revenues also include term license fees which are generated when customers are granted license rights to a given software product for a defined period of time less than 48 months.

License revenues increased 6% for the quarter ended September 30, 2004, and remained relatively flat for the six months ended September 30, 2004, compared to the same periods last year. Weakness in IT spending and customer procurement process slowdowns during the first quarter of fiscal 2005 resulted in the lack of growth in license revenues for the six-month period. While license bookings, which is defined as recognized license revenues plus the net change in deferred license revenues for the period and represents the license value of transactions completed in the period, for the six months ended September 30, 2004 were down slightly from the prior year period, license bookings for the quarter increased 11% over the prior year. The number of license transactions over $1 million during the quarter increased to 19 from 18 in the prior year period, including one transaction over $10 million. The total license value of these 19 transactions was $65.4 million, including amounts recognized and deferred, compared to $38.8 million for the 18 transactions in the comparable prior year period.

For the quarter and six months ended September 30, 2003 and 2004, our recognized license revenues were impacted by the changes in our deferred license revenue balance as follows:


	Three Months Ended						Six Months Ended
	September 30,						September 30,
	2003			2004			2003			2004
	(In millions)
Deferrals of license revenue	$	(28.0	)	$	(47.4	)	$	(49.8	)	$	(69.5	)
Recognition from deferred license revenue		20.0			32.7			43.8			71.5

Net impact on recognized license revenues	$	(8.0	)	$	(14.7	)	$	(6.0	)	$	2.0

Deferred license revenue balance at end of quarter	$	224.3		$	350.3

We expect that our deferred license revenues will grow in fiscal 2005 based on increased flexible contract terms that result in deferral of revenue. Also, because of differing maintenance pricing methodologies for legacy BMC products and Remedy products, license revenues in transactions that include both types of products typically must be deferred under the residual method of accounting for multiple element arrangements. We expect the volume of such joint transactions to increase and, accordingly, expect the deferred license revenues related to them to increase. The contract terms and conditions that result in deferral of revenue recognition for a given transaction result from arm’s length negotiations between us and our customers. During these negotiations, the contract terms

and conditions that result in deferral may be requested by a customer, while in some cases we may suggest inclusion of these terms and conditions where it makes business sense to do so. We may suggest short-term time-based licenses in response to customers’ product mix, pricing and licensing needs. In either case, the resulting contract must be acceptable to both parties. Examples of transactions resulting in the deferral of license revenue would include short-term time-based licenses (generally one to four years), transactions that include both BMC and Remedy products, as noted above, for which vendor-specific objective evidence of the fair value of the maintenance, enhancement and support does not exist, and transactions that include complex terms and conditions for which we do not have vendor-specific objective evidence of fair value of the maintenance, enhancement and support. Once it is determined that license revenue for a particular contract must be deferred, based on the contractual terms and application of revenue recognition policies to those terms, we recognize such license revenue either ratably over the term of the contract or when the revenue recognition criteria are met. Because of this, we generally know the timing of the subsequent recognition of license revenue at the time of deferral. Therefore, the amount of license revenues to be recognized out of the deferred revenue balance in each future quarter is generally predictable, and our total license revenues to be recognized each quarter become more predictable as a larger percentage of those revenues come from the deferred license revenue balance. As of September 30, 2004, the average remaining life of the deferred license revenue balance was approximately three and one half years. Of the total deferred license revenue balance at September 30, 2004, we estimate that we will recognize license revenues of $74.6 million, $110.7 million, $82.3 million and $82.7 million, for the remainder of fiscal 2005, fiscal 2006, fiscal 2007 and thereafter, respectively.

Our domestic operations generated 46% of license revenues for both the quarters ended September 30, 2003 and 2004, and 43% and 46% for the six months ended September 30, 2003 and 2004, respectively. Domestic license revenues for the quarter and six months ended September 30, 2004 increased 8% and 7%, respectively, compared to the comparable periods in the prior fiscal year primarily as a result of Service Management revenue growth, including additional revenues from acquisitions. International license revenues represented 54% of license revenues for both the quarters ended September 30, 2003 and 2004, and 57% and 54% for the six months ended September 30, 2003 and 2004, respectively. International license revenues for the quarter and six months ended September 30, 2004 increased 5% and decreased 5%, respectively, compared to the same periods last year. Foreign currency exchange rate changes caused increases in international license revenues of 4% for the quarter and six months ended September 30, 2004, net of hedging. Excluding this currency impact, international license revenues increased 1% and decreased 9% compared to the same periods ended September 30, 2003.

Maintenance, Enhancement and Support Revenues

Maintenance, enhancement and support revenues represent the ratable recognition of fees to enroll licensed products in our software maintenance, enhancement and support program. Maintenance, enhancement and support enrollment generally entitles customers to product enhancements, technical support services and ongoing compatibility with third-party operating systems, database management systems, networks, storage systems and applications. These fees are generally charged annually and are based on a percentage of the product price. Customers may be entitled to reduced maintenance percentages for entering into long-term maintenance contracts that include prepayment of the maintenance fees or that are supported by a formal financing arrangement. Maintenance revenues also include the ratable recognition of the bundled fees for any initial maintenance services covered by the related perpetual license agreement.

Maintenance revenues increased 6% and 9% for the quarter and six months ended September 30, 2004, over the comparable prior year periods, as a result of the additional maintenance revenue associated with the Magic and Marimba products and the continuing growth in the base of installed Service Management products and the processing capacity on which they run. Maintenance fees increase with new license and maintenance agreements and as existing customers install our products on additional processing capacity. However, discounts tend to increase at higher levels of processing capacity, so that maintenance fees on a per unit of capacity basis are typically reduced in enterprise license agreements. These discounts, combined with an increase in long-term maintenance contracts with reduced maintenance percentages and the slow growth in our license bookings, have led to lower year-over-year growth rates for our maintenance revenues excluding acquisitions, and contributed to the 2% decline in maintenance revenues for the quarter ended September 30, 2004 compared to the preceding quarter ended June 30, 2004. Historically, our maintenance renewal rates have been high, but economic and competitive pressures could cause customers to reduce their licensed capacity and, therefore, the capacity upon which our maintenance, enhancement and support fees are charged. Of the total deferred maintenance revenue balance at September 30, 2004, we will recognize maintenance revenues of $302.6 million, $352.5 million, $216.1 million and $154.0 million, for the remainder of fiscal 2005, fiscal 2006, fiscal 2007 and thereafter, respectively.

Product Line Revenues


	Three Months Ended							Six Months Ended
	September 30,							September 30,
	2003		2004		Change			2003		2004		Change
	(In millions)							(In millions)
Mainframe Management:
Mainframe Data Management	$	90.6	$	90.1		(0.6	)%	$	173.5	$	175.6		1.2	%
MAINVIEW		31.5		29.3		(7.0	)%		62.4		56.2		(9.9	)%

		122.1		119.4		(2.2	)%		235.9		231.8		(1.7	)%
Distributed Systems Management:
PATROL		67.3		57.2		(15.0	)%		128.9		113.4		(12.0	)%
Distributed Systems Data Management		28.1		29.5		5.0	%		54.0		56.1		3.9	%
Scheduling & Output Management		31.7		34.0		7.3	%		62.6		64.5		3.0	%

		127.1		120.7		(5.0	)%		245.5		234.0		(4.7	)%
Service Management		57.2		87.3		52.6	%		107.8		161.6		49.9	%
Identity Management		6.3		5.0		(20.6	)%		13.9		10.1		(27.3	)%
Other		0.2		—		(100.0	)%		0.9		—		(100.0	)%

Total license & maintenance revenues	$	312.9	$	332.4		6.2	%	$	604.0	$	637.5		5.5	%

Our solutions are broadly divided into four core product categories. The Mainframe Management product category includes products designed for managing database management systems on mainframe platforms. The Distributed Systems Management product category includes our systems management and monitoring, scheduling and output management solutions. The Service Management product category includes our service, change and asset management solutions. The Identity Management product category includes products that facilitate user registration and password administration.

Mainframe Management revenues represented 39% of our total software revenues for the quarter and six months ended September 30, 2003 and 36% for the quarter and six months ended September 30, 2004. Total software revenues for this product category decreased 2% in the quarter and six months ended September 30, 2004, from the same periods in the prior year. The overall revenue decline for the quarter and six months ended September 30, 2004 was primarily a result of the decrease in license and maintenance revenues for the MAINVIEW product line as our past success in displacing Candle products has led to less current opportunities for this product line and slower growth in customer demand for capacity.

Distributed Systems Management revenues represented 41% and 36% of our total software revenues for the quarters ended September 30, 2003 and 2004, respectively, and 41% and 37% for the six months ended September 30, 2003 and 2004, respectively. Total software revenues for this product category decreased 5% for the quarter and six months ended September 30, 2004, compared to the prior year periods primarily as a result of declines in license revenues for the PATROL product line in both periods. This decrease in license revenues was partially offset in the three and six months ended September 30, 2004 by increases in maintenance revenues for the Scheduling & Output Management product line due to the continuing growth in the base of installed products and the processing capacity on which they run and increases in license revenues for the Distributed Systems Data Management product line.

Service Management revenues represented 18% and 26% of our total software revenues for the quarters ended September 30, 2003 and 2004, respectively, and 18% and 25% for the six months ended September 30, 2003 and 2004, respectively. Total software revenues for this product category increased 53% and 50% in the quarter and six months ended September 30, 2004, from the same periods in the prior year as license revenues increased 68% and 52% and maintenance revenues increased 43% and 48%, respectively. The increases were primarily due to the acquisitions of Marimba and Magic during the second quarter of fiscal 2005 and the fourth quarter of fiscal 2004, respectively, and growth of Remedy’s core business.

Identity Management revenues contributed 2% of total software revenues for the quarters and six months ended September 30, 2003 and 2004. Total software revenues for this product category decreased 21% and 27% in the quarter and six months ended September 30, 2004, respectively, from the same periods in the prior year. Identity Management license revenues decreased 42% and 53%, for the quarter and six months ended September 30, 2004, respectively, and maintenance revenues decreased 11% for the quarter and six months ended September 30, 2004, as compared to the prior year periods.

Professional Services Revenues

Professional services revenues, representing fees from implementation, integration and education services performed during the periods increased 9% and 10% for the quarter and six months ended September 30, 2004, compared to the prior year periods. These increases are primarily a result of Service Management professional services growth, including additional revenues from acquisitions.

Operating Expenses


	Three Months Ended							Six Months Ended
	September 30,							September 30,
	2003		2004		Change			2003		2004		Change
	(In millions)							(In millions)
Selling and marketing	$	140.2	$	131.2		(6.4	)%	$	278.1	$	255.9		(8.0	)%
Research, development and support		147.1		117.7		(20.0	)%		274.4		227.0		(17.3	)%
Cost of professional services		20.0		23.2		16.0	%		39.0		43.7		12.1	%
General and administrative		47.9		49.9		4.2	%		85.2		92.6		8.7	%
Settlement of litigation		—		11.3		—			—		11.3		—
Amortization of acquired technology and intangibles		15.3		19.4		26.8	%		30.9		35.5		14.9	%
Acquired research and development		—		0.2		—			—		0.2		—

Total operating expenses	$	370.5	$	352.9		(4.8	)%	$	707.6	$	666.2		(5.9	)%

Exit Activities and Related Costs

During the year ended March 31, 2004, we achieved a better alignment of our cost structure with market conditions. Our actions included the involuntary termination of approximately 785 employees during the quarter ended September 30, 2003. We also exited leases in certain locations, reduced the square footage required to operate some locations and relocated some operations to lower cost facilities. These relocation efforts were completed as of December 31, 2003. The expenses related to the exit activities for the quarter and six months ended September 30, 2003 are reflected in the accompanying Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) as follows:


	Severance & Related				Incremental
	Costs		Facilities		Depreciation		Total
	(In millions)
Selling and marketing expenses	$	14.2	$	0.7	$	3.4	$	18.3
Research, development and support expenses		8.7		—		2.8		11.5
Cost of professional services		2.2		—		—		2.2
General and administrative expenses		1.8		—		0.6		2.4

Total included in operating expenses	$	26.9	$	0.7	$	6.8	$	34.4

As of September 30, 2004, $51.6 million of severance and facilities costs related to actions completed under the plan remained accrued for payment in future periods, as follows:


	Balance at										Balance at
	March 31,				Adjustments			Cash Payments Net			September 30,
	2004		Accretion		to Estimates			of Sublease Income			2004
	(In millions)
Severance and related costs	$	3.9	$	—	$	0.1		$	(2.8	)	$	1.2
Facilities costs		64.7		0.9		(1.3	)		(13.9	)		50.4

Total accrual	$	68.6	$	0.9	$	(1.2	)	$	(16.7	)	$	51.6

The amounts accrued at September 30, 2004 related to facilities costs represent the remaining fair value of lease obligations for exited locations, as determined at the cease-use dates for those facilities, net of estimated sublease income that could be reasonably obtained in the future, and will be paid out over the remaining lease terms, the last of which ends in fiscal 2011. We do not expect any significant additional severance or facilities charges subsequent to September 30, 2004 other than potential adjustments to lease accruals based on actual subleases differing from estimates. We expect that the vast majority of the severance and related costs will be paid by the end of fiscal 2005.

Selling and Marketing

Our selling and marketing expenses primarily include personnel and related costs, sales commissions and costs associated with advertising, industry trade shows and sales seminars. Selling and marketing expenses represented 42% and 37% of total revenues for the quarters ended September 30, 2003 and 2004, respectively, and 43% and 38% of total revenues for the six months ended September 30, 2003 and 2004, respectively. Selling and marketing expenses decreased 6% and 8% for the quarter and six months ended September 30, 2004, as compared to the prior year primarily as a result of the costs related to our exit activities in the prior year, as discussed above. Excluding exit costs, selling and marketing expenses increased 7% and decreased 2% for the quarter and six months ended September 30, 2004, respectively, as compared to the prior year. The increase for the quarter, excluding exit costs, was primarily due to increased bad debt expense and personnel expenses, a significant portion of which related to increased bonuses resulting from improved attainment of our quarterly goals. The decline for the six-month period, excluding exit costs, was primarily due to decreased depreciation expense for computer hardware and software as a result of certain assets becoming fully depreciated since the prior year and decreased personnel expense resulting from our restructuring activities in the prior year.

Research, Development and Support

Research, development and support expenses mainly comprise personnel costs related to software developers and development support personnel, including software programmers, testing and quality assurance personnel and writers of technical documentation such as product manuals and installation guides. These expenses also include costs associated with the maintenance, enhancement and support of our products, computer hardware/software costs, telecommunications and personnel expenses necessary to maintain our data processing center, royalties and the effect of software development cost capitalization and amortization.

Research, development and support expenses were reduced in the quarters and six months ended September 30, 2003 and 2004 by amounts capitalized in accordance with SFAS No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.” We capitalize our software development costs when the projects under development reach technological feasibility, as defined by SFAS No. 86, and amortize these costs over the products’ estimated economic lives, which are typically three years.

The following table summarizes the amounts capitalized and amortized during the three months and six months ended September 30, 2003 and 2004. Amortization for these periods includes amounts accelerated for certain software products that were not expected to generate sufficient future revenues to realize the carrying value of the assets.


	Three Months Ended						Six Months Ended
	September 30,						September 30,
	2003			2004			2003			2004
	(In millions)
Software development and purchased software costs capitalized	$	(16.8	)	$	(15.4	)	$	(31.8	)	$	(29.6	)
Total amortization		32.4			18.1			55.6			37.5

Net impact on research, development and support expenses	$	15.6		$	2.7		$	23.8		$	7.9

Accelerated amortization included in total amortization above	$	7.6		$	0.4		$	7.6		$	1.2

Research, development and support expenses represented 44% and 33% of total revenues for the quarters ended September 30, 2003 and 2004, respectively, and 43% and 33% for the six months ended September 30, 2003 and 2004, respectively. Research, development and support expenses decreased 20% and 17% in the quarter and six months ended September 30, 2004, compared to the same periods in the prior year. Excluding costs related to exit activities in fiscal 2004 and fiscal 2005, research, development and support expenses decreased by 13% and 12% for the quarter and six months ended September 30, 2004, respectively, compared to the same periods in the prior year. The decrease is primarily due to an overall reduction in personnel and facilities costs resulting from our restructuring activities in fiscal 2004, only somewhat offset by personnel growth in lower-cost locations and from acquisitions, and the net effect of software cost capitalization and amortization shown above. The decrease in the net effect of software cost capitalization and amortization is primarily a result of decreased amortization expense. Capitalization declined during fiscal 2004 due to the overall reduction in research and development headcount and the development of agentless and channel-ready products that require shorter development time. Lower amounts capitalized since that period, coupled with mature products becoming fully amortized, have led to reduced amortization during the quarter and six months ended September 30, 2004.

Cost of Professional Services

Cost of professional services consists of personnel costs associated with implementation, integration and education services that we perform for our customers and the related infrastructure to support this business. The cost of professional services represented 6% and 7% of total revenues for the quarters ended September 30, 2003 and 2004, respectively, and 6% of total revenues for the six-month periods. Cost of professional services increased 16% and 12% for the quarter and six months ended September 30, 2004 compared to the same prior year periods. Excluding costs related to exit activities in fiscal 2004, cost of professional services increased 30% and 19% for the quarter and six months ended September 30, 2004 compared to the prior year periods. These increases are primarily due to increased third-party implementation services primarily related to Remedy products that were partially offset by decreased personnel costs resulting from our restructuring activities in fiscal 2004.

General and Administrative

General and administrative expenses are comprised primarily of compensation and personnel costs within executive management, finance and accounting, IT, facilities management, legal and human resources. Other costs included in general and administrative expenses are fees paid for outside legal and accounting services, consulting projects and insurance. General and administrative expenses represented 14% of total revenues in the quarters ended September 30, 2003 and 2004, and 13% and 14% of total revenues for the six months ended September 30, 2003 and 2004, respectively. These expenses increased 4% and 9% for the quarter and six months ended September 30, 2004, compared to the same periods in the prior year. Excluding costs related to exit activities in fiscal 2004, general and administrative expenses increased by 9% and 12% for the quarter and six months ended September 30, 2004, compared to the same periods in the prior year. The increase included higher professional fees, consisting of legal, accounting and consulting fees due, in part, to Sarbanes Oxley compliance efforts, and higher personnel costs, a significant portion of which related to expanded accounting staff and an increase in bonus expense resulting from improved attainment of our quarterly goals.

Settlement of Litigation

We reached an agreement in principle with Nastel Technologies, Inc. (Nastel) for a no-fault settlement whereby we will pay Nastel $11.3 million. In July 2001, Nastel filed a complaint against us alleging among other claims that Boole and Babbage, a company that we acquired in 1999, had exceeded license rights of software prior to its acquisition by us, and that we then stopped marketing certain products in 1999. The settlement payment covers all claims involved in this action and is expected to be made during the quarter ending December 31, 2004.

Amortization of Acquired Technology and Intangibles

Under the purchase accounting method for our acquisitions, portions of the purchase prices were allocated to acquired software and other intangible assets. We are amortizing certain of these intangibles over two to four-year periods, which reflect the estimated useful lives of the respective assets. The increase in amortization expense for the quarter and six months ended September 30, 2004 as compared to the prior year periods is primarily due to the acquisition of Magic in the fourth quarter of fiscal 2004 and the acquisition of Marimba in the second quarter of fiscal 2005.

Other Income, Net

Other income, net consists primarily of interest earned on cash, cash equivalents, marketable securities and finance receivables, rental income on owned facilities and gains and losses on marketable securities and other investments. For the quarter and six months ended September 30, 2004, other income, net was $15.7 million and $33.3 million, respectively, reflecting a decrease of $2.1 million and $5.3 million from the same periods of fiscal 2004. The decrease in other income, net for the quarter and six months is primarily due to losses on investments in the first half of fiscal 2005. For the six months ended September 30, 2004, the decline is also a result of the gain on the licensing of our PATROL Storage Manager product to EMC Corporation in the prior year.

Income Tax Provision (Benefit)

For the quarter and six months ended September 30, 2004, our income tax provision was $5.2 million and $24.8 million, respectively, compared to a benefit of $5.7 million and $6.0 million, respectively, for the same periods in the prior year. Included in income tax expense for the six months ended September 30, 2004 is an accrual of approximately $11.1 million recorded in the quarter ended June 30, 2004, intended to satisfy income tax assessments that may result from the examination of our corporate tax returns that have been filed in domestic and foreign jurisdictions and to increase the valuation allowance for certain deferred tax assets. Including these adjustments to income tax accruals, our effective tax rates for the quarter and six months ended September 30, 2004 were 29% and 51%, respectively, as compared to 30% and 24%, respectively, for the comparable prior year periods.

During the six months ended September 30, 2004, we and the Internal Revenue Service Appeals Division (IRS Appeals) resolved our income tax audits for the fiscal years ended March 31, 1998 and 1999. Accordingly, we have now closed all federal corporate income tax audit issues for years prior to fiscal 2000. The settlement with IRS Appeals did not have a material impact on our consolidated financial position or results of operations.

The IRS has completed its examination of our federal income tax returns filed for the tax years ended March 31, 2000 and 2001 and issued its Revenue Agent Report. We have filed our protest letter and requested a conference with IRS Appeals, which is scheduled in early calendar 2005. We believe that we have meritorious defenses to the proposed adjustments, that adequate provisions for income taxes have been made and, therefore, that the ultimate resolution of the issues will not have a material adverse impact on our consolidated financial position or results of operations. During the quarter ended September 30, 2004, the IRS commenced the examination of our fiscal 2002 and 2003 federal income tax returns.

On October 22, 2004, President Bush signed into law the American Jobs Creation Act of 2004 (Act). This new Act is one of the most comprehensive changes to U.S. international tax law since the Tax Reform Act of 1986. We are studying various aspects of the Act, including the provision allowing for a one-time 85% dividends received deduction for cash dividends generated from our international operations by our controlled foreign corporations. If because of these new facts, we no longer maintain our reinvestment plans we will be required to accrue the incremental tax expense under the Act on those funds we do not consider indefinitely reinvested. The incremental provision for income taxes would be reflected during the quarter in which we change our determination with respect to our reinvestment plans.

Recently Issued Accounting Pronouncement

In March 2004, the Emerging Issues Task Force reached a consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-1”). EITF 03-1 provides guidance on other-than-temporary impairment models for marketable debt and equity securities accounted for under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” as well as non-marketable equity securities accounted for under the cost method. The consensus includes a basic three-step model to evaluate whether an investment is other-than-temporarily impaired. We apply and will prospectively apply the provisions of EITF 03-1 to all our current and future investments within the scope of the consensus. The adoption of EITF 03-1 did not have a material effect on our consolidated financial position or results of operations.

Liquidity and Capital Resources

One of our key goals is to maintain or improve our capital structure. Our key metrics for analyzing the strength of our balance sheet are summarized in the tables below and the discussion that follows addresses the factors that impact these key metrics:


	Six Months Ended
	September 30,
	2003		2004
	(In millions)
Cash flow metrics:
Cash provided by (used in) operating activities	$	158.1	$	100.1
Treasury stock acquired	$	90.0	$	45.0
Cash paid for technology acquisitions and other investments, net of cash acquired	$	6.7	$	212.0


	March 31,		September 30,
	2004		2004
	(In millions)
Balance sheet metrics:
Cash, cash equivalents and short and long-term marketable securities	$	1,213.0	$	1,019.3
Working capital	$	438.0	$	102.1

Operating Activities

The table below aggregates certain line items from our consolidated cash flow statements to present the key items affecting our cash flows from operating activities:


	Six Months Ended
	September 30,
	2003			2004
	(In millions)
Net earnings (loss) after non-cash adjustments	$	116.2		$	130.3
(Increase) decrease in finance receivables		105.0			1.7
Increase (decrease) in payables to third-party financing institutions for finance receivables		(34.2	)		(25.4	)
All other, net		(28.9	)		(6.5	)

Net cash provided by (used in) operating activities	$	158.1		$	100.1

• For the six months ended September 30, 2004, the increase in net earnings (loss) after non-cash adjustments is primarily due to the increase in net earnings for the period over the net loss reported in the prior year period.

• Working capital decreased from March 31, 2004 to September 30, 2004 primarily due to the use of cash for the Marimba acquisition and the purchase of long-term marketable securities.

• As discussed above under Settlement of Litigation, we expect to make a one-time cash payment of $11.3 million to Nastel during the quarter ending December 31, 2004.

• We continue to finance our operations primarily through funds generated from operations. Our primary source of cash is the sale of our software licenses, software maintenance, enhancement and support and professional services. We believe that our existing cash balances and funds generated from operating and investing activities will be sufficient to meet our liquidity requirements for the foreseeable future. However, we have a history of acquiring companies. If we were to make a significant acquisition in the future, we might find it advantageous to utilize third-party financing sources based on factors such as our then available cash and its source (i.e., cash held in the United States vs. international), the cost of financing and our internal cost of capital.

Investing Activities

The table below aggregates certain line items from our consolidated cash flow statements to present the key items affecting our cash flows from investing activities:


	Six Months Ended
	September 30,
	2003			2004
	(In millions)
Cash paid for technology acquisitions and other investments, net of cash acquired, and adjustments to cash paid for prior period acquisitions	$	0.5		$	(212.0	)
Proceeds from maturities/sales of marketable securities		130.2			187.0
Purchases of marketable securities		(267.2	)		(115.5	)
All other, net		(52.6	)		(58.8	)

Net cash provided by (used in) investing activities	$	(189.1	)	$	(199.3	)

• The main source of cash from investing activities is the proceeds from maturities/sales of marketable securities.

• Cash paid for technology acquisitions and other investments, net of cash acquired, for the six months ended September 30, 2004 includes $203.4 million, including direct costs of the transaction, for our purchase of Marimba.

• The main components of other cash used in investing activities are purchases of property and equipment, primarily computer hardware and software, and capitalization of software development costs.

Financing Activities

The table below aggregates certain line items from our consolidated cash flow statements to present the key items affecting our cash flows from financing activities:


	Six Months Ended
	September 30,
	2003			2004
	(In millions)
Treasury stock acquired	$	(90.0	)	$	(45.0	)
Payments on capital leases		—			(2.3	)
Stock options exercised and other		9.0			13.4

Net cash used in financing activities	$	(81.0	)	$	(33.9	)

• There were no borrowings during the six months ended September 30, 2003 and 2004, and the main use of cash for financing activities was the acquisition of treasury stock. During the six months ended September 30, 2004, approximately 2.8 million shares of treasury stock were purchased. We plan to be consistent with our historical treasury stock purchase practices, subject to market conditions, other possible uses of our cash and our domestic liquidity position.

• The exercise of stock options was the primary source of cash in financing activities.

• Capital lease obligations of $16.7 million and $4.2 million were incurred during the six months ended September 30, 2003 and 2004, respectively, for computer hardware.

The Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2003 and 2004 are included in the accompanying Condensed Consolidated Financial Statements.

Cash, Cash Equivalents and Marketable Securities

At September 30, 2004, our cash, cash equivalents and marketable securities were $1.0 billion, a decline of $193.7 million from the March 31, 2004 balance. This decrease is primarily due to cash funding for the Marimba acquisition and treasury stock purchases, which more than offset positive operating cash flow. Approximately 88% of the $1,019.3 million of cash, cash equivalents and marketable securities at September 30, 2004 is held in international locations and was largely generated from our international operations. Our international operations have generated approximately $798.0 million of earnings for which U.S. income taxes have not been recorded. These earnings would be subject to U.S. income tax if repatriated to the United States. The potential deferred tax liability for these earnings is approximately $260.0 million; however, we have not provided a deferred tax liability on any portion of the $798.0 million as we plan to utilize our cash in international locations for foreign investment purposes. During fiscal 2003 and 2004, we utilized cash held in international locations to fund a portion of the Remedy purchase price, based upon the valuation of the foreign assets of Remedy acquired, and the IT Masters and Magic purchase prices. On October 22, 2004, President Bush signed into law the American Jobs Creation Act of 2004 (Act). This new Act is one of the most comprehensive changes to U.S. international tax law since the Tax Reform Act of 1986. We are studying various aspects of the Act, including the provision allowing for a one-time 85% dividends received deduction for cash dividends generated from our international operations by our controlled foreign corporations. If because of these new facts, we no longer maintain our reinvestment plans we will be required to accrue the incremental tax expense under the Act on those funds we do not consider indefinitely reinvested. The incremental provision for income taxes would be reflected during the quarter in which we change our determination with respect to our reinvestment plans.

Our marketable securities are primarily investment grade and highly liquid. A significant dollar portion of our marketable securities is invested in securities with maturities beyond one year, and while typically yielding greater returns, investing in such securities reduces reported working capital.

Trade Finance Receivables

We provide financing on a portion of our sales transactions to customers that meet our specified standards of creditworthiness. Our practice of providing financing at reasonable interest rates enhances our competitive position. We participate in established programs with third-party financial institutions to sell a portion of our finance receivables, enabling us to collect cash sooner and remove credit risk. Such transfers of qualifying receivables typically occur in the quarter subsequent to the quarter in which the finance receivable is generated. For a detailed discussion of these programs, see the Liquidity and Capital Resources section and Note 4 to our Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended March 31, 2004. During the six months ended September 30, 2003 and 2004, we transferred $112.4 million and $67.1 million, respectively, of such receivables through these programs. The high credit quality of our finance receivables and the existence of these third-party facilities extend our ability to offer financing to qualifying customers on an ongoing basis. However, to meet the needs of our customers we have been providing more licensing options, and this increased focus on flexibility results in more customer transactions where cash payments will be received over time. This flexibility has reduced our ability to transfer finance receivables and has reduced our cash flow from operations.

Treasury Stock Purchases

On April 24, 2000, our board of directors authorized the purchase of up to $500.0 million in common stock, and on July 30, 2002, they authorized the purchase of an additional $500.0 million. During the quarter and six months ended September 30, 2004, we purchased approximately 1.6 million and 2.8 million shares for $25.0 million and $45.0 million, respectively. From the inception of the repurchase plan through September 30, 2004, we have purchased 42.1 million shares for $737.6 million. See Issuer Purchases of Equity Securities below for a monthly detail of fiscal 2005 treasury stock purchases. The repurchase program is funded solely with domestic cash and marketable securities and, therefore, affects the domestic versus international liquidity balances.

Contractual Obligations

Our contractual obligations are disclosed in our Annual Report on Form 10-K for the year ended March 31, 2004. There have been no material changes to our contractual obligations since March 31, 2004.

Off-Balance Sheet Arrangements

We use off-balance sheet arrangements where the economics of the arrangements and sound business principles warrant their use. Our principal use of off-balance sheet arrangements has historically been in connection with the securitization and sale of trade finance receivables generated in the ordinary course of business by us. We have not transferred any receivables from customers through securitization since the third quarter of fiscal 2003. We utilize a financial subsidiary and various wholly owned special-purpose entities in these transfers. These entities are fully consolidated in our financial statements. We record the transfers as sales of the related accounts receivable when we are considered to have surrendered control of such receivables in accordance with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” See further discussion of our off-balance sheet arrangements in Note 4 of our Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended March 31, 2004.

We do not expect our use of off-balance sheet arrangements to return to the levels experienced before we began to offer more flexible license terms to our customers.

Acquisitions

On July 15, 2004, we acquired Marimba, Inc. for cash of $234.4 million, including direct costs of the transaction, or $203.4 million, net of cash acquired. Marimba’s results have been included in our Condensed Consolidated Financial Statements since the acquisition date. This acquisition will strengthen our BSM-related offerings through the addition of IT asset discovery and asset, change and configuration management. We funded the cash purchase price from existing cash balances.

Certain Risks and Uncertainties

We operate in a dynamic and rapidly changing environment that involves numerous risks and uncertainties. The following section describes some, but not all, of the risks and uncertainties that we believe may adversely affect our business, financial condition or results of operations.

We may experience a shortfall in revenue, license bookings or earnings in any given quarter or may announce lower than forecasted revenue, license bookings or earnings, which could cause our stock price to decline.

Our revenue, license bookings and earnings are difficult to forecast and are likely to fluctuate from quarter to quarter due to many factors. In addition, a significant amount of our license transactions are completed during the final weeks and days of the quarter, and therefore we generally do not know whether revenue, earnings, license bookings and/or cash flows will have met expectations until shortly after the end of the quarter. Any significant revenue, license bookings or earnings shortfall or lowered forecasts could cause our stock price to decline substantially. Factors that could affect our financial results include, but are not limited to:

• the unpredictability of the timing and magnitude of our sales through direct sales channels, value-added resellers and distributors, which tend to occur late in each quarter;

• the possibility that our customers may choose to license our software under terms and conditions that require revenues to be deferred or recognized ratably over time rather than upfront and that we may not accurately forecast the resulting mix of license transactions between upfront and deferred revenues;

• the possibility that our customers may defer or limit purchases as a result of reduced information technology budgets or reduced data processing capacity demand;

• the possibility that our customers may delay or limit purchases as a result of increased requirements related to the documentation of and focus on internal controls and mitigation of risks, all related to Sarbanes-Oxley compliance efforts;

• the possibility that our customers may elect not to license our products for additional processing capacity until their actual processing capacity or expected future processing capacity exceeds the capacity they have already licensed from us;

• the possibility that our customers may defer purchases of our products in anticipation of new products or product updates from us or our competitors;

• the timing of new product introductions by us and the market’s acceptance of new products;

• higher than expected operating expenses;

• changes in our pricing and distribution terms and/or those of our competitors; and

• the possibility that our business will be adversely affected as a result of the threat of significant external events that increase global economic uncertainty.

Investors should not rely on the results of prior periods as an indication of our future performance. Our operating expense levels are based, in significant part, on our expectations of future revenue. If we have a shortfall in revenue in any given quarter, we will not be able to reduce our operating expenses for that quarter proportionally in response. Therefore, any significant shortfall in revenue will likely have an immediate adverse effect on our operating results for that quarter.

The markets for some or all of our key product lines may not grow.

Some or all of our key product lines may not grow, may decline in growth, or customers may decline or forgo use of products in some or all of these product areas. A decline in these product areas could result in decreased demand for our products, which would adversely impact our business, financial condition, operating results, and cash flow. Currently, a significant portion of our planned revenue growth is attributable to the Service Management product category. Although we believe that businesses will continue to demand the products in this area, there can be no assurance as to whether such future demand will continue to grow or not. Slower growth in this line will adversely affect our revenues.

We may have difficulty achieving our cash flow from operations goal.

Our quarterly cash flow is and has been volatile. If our cash generated from operations proved in some future period to be materially less than the market expects, the market price of our common stock could decline. To meet the needs of our customers, we have been providing more licensing options, and this increased focus on flexibility may lead to more contracts that will be recognized ratably versus upfront and where cash payments may be received over time versus upfront. Factors that could adversely affect our cash flow from operations in the future include: reduced net earnings; increased time required for the collection of accounts receivable; an increase in uncollectible accounts receivable; a significant shift from multi-year committed contracts to short-term contracts; a reduced ability to transfer finance receivables to third parties and thus increased credit risk assumed by us; an increase in contracts where expenses such as sales commissions are paid upfront but payments from customers are collected over time; reduced renewal rates for maintenance; and a reduced yield from marketable securities and cash and cash equivalents balances.

Maintenance revenue could decline.

Maintenance revenues have increased in each of the last three fiscal years as a result of acquisitions and the continuing growth in the base of installed products and the processing capacity on which they run. Maintenance fees increase as the processing capacity on which the products are installed increases; consequently, we receive higher absolute maintenance fees with new license and maintenance agreements and as existing customers install our products on additional processing capacity. Due to increased discounting for higher levels of additional processing capacity, the maintenance fees on a per unit of capacity basis are typically reduced in enterprise license agreements. In addition, customers may be entitled to reduced maintenance percentages for entering into long-term maintenance contracts that include prepayment of the maintenance fees or that are supported by a formal financing arrangement. These discounts, combined with an increase in long-term maintenance contracts with reduced maintenance percentages and the slow growth in our license bookings, have led to lower year-over-year growth rates for our maintenance revenues excluding acquisitions. Declines in our license bookings, increases in long-term maintenance contracts and/or increased discounting would lead to declines in our maintenance revenues. Although renewal rates remain high, should customers migrate from their mainframe applications or find alternatives to our products, increased cancellations could lead to declines in our maintenance revenues.

Our stock price is volatile.

Our stock price has been and is highly volatile. Our stock price is highly influenced by current expectations of our future revenues, earnings and cash flows from operations. Any failure to meet anticipated revenue, license bookings, earnings or cash flow from operations in a period or any negative change in our perceived long-term growth prospects would likely have a significant adverse effect on our stock price.

Intense competition and pricing pressures could adversely affect our earnings.

The market for systems management software is highly competitive. We compete with a variety of software vendors including IBM, Hewlett Packard (HP), Computer Associates (CA) and a number of smaller software vendors. We derived a significant portion of our total revenues in fiscal 2004 from software products for IBM and IBM-compatible mainframe computers. IBM continues, directly and through third parties, to enhance and market its utilities for IMS and DB2 as lower cost alternatives to the solutions provided by us and other independent software vendors. Although such utilities are currently less functional than our solutions, IBM continues to invest in the IMS and DB2 utility market. If IBM is successful with its efforts to achieve performance and functional equivalence with our IMS, DB2 and other products at a lower cost, our business would be materially adversely affected. In addition, IBM acquired Candle Corporation whose products compete primarily with our MAINVIEW® mainframe monitoring product line. As a large hardware vendor and outsourcer of IT services, IBM has the ability to bundle its other goods and services with its software and offer packaged solutions to customers, which could result in increased pricing pressure. To date, our solutions have competed well against IBM’s because we have developed advanced automation and artificial intelligence features and our utilities have maintained a speed advantage. In addition, we believe that because we provide enterprise management solutions across multiple platforms we are better positioned to provide customers with comprehensive management solutions for their complex multi-vendor IT environments than integrated hardware and software companies like IBM. CA is also competing with us in these markets. Competition has led to increased pricing pressures within the mainframe software markets. We continue to reduce the cost to our customers of our mainframe tools and utilities in response to such competitive pressures. Although to date we have not experienced significant competition from Microsoft, their dominant position in the operating system market makes them capable of exerting competitive pressure in the systems management market as well. We also face competition from several niche software vendors, particularly for our distributed systems product lines. In addition, the software industry is experiencing continued consolidation. There is a risk that some of our competitors may combine and consolidate market positions or combine technology, making them stronger competitors.

Our products must remain compatible with ever-changing operating and database environments.

IBM, HP, Microsoft and Oracle are by far the largest suppliers of systems and database software and, in many cases, are the manufacturers of the computer hardware systems used by most of our customers. Historically, operating and database system developers have modified or introduced new operating systems, database systems, systems software and computer hardware. Such new products could incorporate features which perform functions currently performed by our products or could require substantial modification of our products to maintain compatibility with these companies’ hardware or software. Although we have to date been able to adapt our products and our business to changes introduced by hardware manufacturers and operating and database system software developers, there can be no assurance that we will be able to do so in the future. Failure to adapt our products in a timely manner to such changes or customer decisions to forego the use of our products in favor of those with comparable functionality contained either in the hardware or operating system could have a material adverse effect on our business, financial condition and operating results.

Future product development is dependent upon access to third-party source code.

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

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

Operating and database system software developers have in the past provided us with early access to pre-generally available (GA) versions of their software in order to have input into the functionality and to ensure that we can adapt our software to exploit new functionality in these systems. Some companies, however, may adopt more restrictive policies in the future or impose unfavorable terms and conditions for such access. These restrictions may result in higher research and development costs for us in connection with the enhancement and modification of our existing products and the development of new products. Although we do not expect that such restrictions will have this adverse effect, there can be no assurances that such restrictions or other restrictions will not have a material adverse effect on our business, financial condition and operating results.

Future product development and sales are dependent on access to and reliability of third-party software products.

Certain of our software products contain components developed and maintained by third-party software vendors. We expect that we may have to incorporate software from third-party vendors in our future products or product offerings. We may not be able to replace the functionality provided by the third-party software currently offered with our products if that software becomes obsolete, defective or incompatible with future versions of our products or is not adequately maintained or updated or if our relationship with the third-party vendor terminates. Although we believe there are adequate alternate sources for the technology licensed to us, any significant interruption in the availability of these third-party software products on commercially acceptable terms or defects in these products could delay development of future products or enhancement of future products and harm our sales. This could adversely affect our business, financial condition, operating results and cash flows.

Failure to adapt to technological change could adversely affect our earnings.

If we fail to keep pace with technological change in our industry, such failure would have an adverse effect on our revenues and earnings. We operate in a highly competitive industry characterized by rapid technological change, evolving industry standards, changes in customer requirements and frequent new product introductions and enhancements. During the past several years, many new technological advancements and competing products entered the marketplace. The distributed systems and application management markets in which we operate are far more crowded and competitive than our traditional mainframe systems management markets. Our ability to compete effectively and our growth prospects depend upon many factors, including the success of our existing distributed systems products, the timely introduction and success of future software products, and the ability of our products to interoperate and perform well with existing and future leading databases and other platforms supported by our products. We have experienced long development cycles and product delays in the past, particularly with some of our distributed systems products, and expect to have delays in the future. Delays in new product introductions or less-than-anticipated market acceptance of these new products are possible and would have an adverse effect on our revenues and earnings.

Discovery of errors in our software could adversely affect our earnings.

The software products we offer are inherently complex. Despite testing and quality control, we cannot be certain that errors will not be found in current versions, new versions or enhancements of our products after commencement of commercial shipments. If new or existing customers have difficulty deploying our products or require significant amounts of customer support, our operating margins could be harmed. Moreover, we could face possible claims and higher development costs if our software contains undetected errors or if we fail to meet our customers’ expectations. With our BSM strategy, these risk increase because we are combining already complex products to create solutions that are even more complicated than the aggregation of their product components. Significant technical challenges also arise with our products because our customers purchase and deploy our products across a variety of computer platforms and integrate them with a number of third-party software applications and databases. These combinations increase our risk further because in the event of a system-wide failure, it may be difficult to determine which product is at fault; thus, we may be harmed by the failure of another supplier’s products. As a result of the foregoing, we could experience:

• loss of or delay in revenues and loss of market share;

• loss of customers;

• damage to our reputation;

• failure to achieve market acceptance;

• diversion of development resources;

• increased service and warranty costs;

• legal actions by customers against us which could, whether or not successful, increase costs and distract our management; and

• increased insurance costs.

In addition, a product liability claim, whether or not successful, could be time-consuming and costly and thus could have a materially adverse affect on our business, results of operations or financial positions.

Failure to maintain our existing distribution channels and develop additional channels in the future could adversely affect revenues and earnings.

The percentage of our revenue from sales of our products and services through distribution channels such as systems integrators and value-added resellers is increasing. Conducting business through indirect distribution channels presents a number of risks, including:

• each of our systems integrators and value-added resellers can cease marketing our products and services with limited or no notice and with little or no penalty;

• we may not be able to replace existing or recruit additional systems integrator or value-added resellers if we lose any of our existing ones;

• our existing systems integrators and value-added resellers may not be able to effectively sell new products and services that we may introduce;

• we do not have direct control over the business practices adopted by our systems integrators and value-added resellers;

• our systems integrators and value-added resellers may also offer competitive products and services and as such, may not give priority to the marketing of our products and services as compared to our competitors’ products; and

• we may face conflicts between the activities of our indirect channels and our direct sales and marketing activities.

Our customers may not accept our product strategies.

Historically, we have focused on selling software products to address specific customer problems associated with their applications. Our BSM strategy requires us to integrate multiple software products so that they work together to provide comprehensive systems management solutions. There can be no assurance that customers will perceive a need for such solutions. In addition, there may be technical difficulties in integrating individual products into a combined solution that may delay the introduction of such solutions to the market or adversely affect the demand for such solutions. We may also adopt different sales strategies for marketing our products, and there can be no assurance that our strategies for selling solutions will be successful.

Changes to compensation of our sales organization may have unintended effects.

We update our compensation plans for the sales organization periodically. These plans are intended to align with our business objectives of providing customer flexibility and satisfaction. The compensation plans may encourage behavior not anticipated or intended as it is implemented, which could adversely affect our business, financial condition, operating results, and cash flow.

Risks related to business combinations.

As part of our overall strategy, we have acquired or invested in, and plan to continue to acquire or invest in, complementary companies, products, and technologies and to enter into joint ventures and strategic alliances with other companies. Risks commonly encountered in such transactions include: the difficulty of assimilating the operations and personnel of the combined companies; the risk that we may not be able to integrate the acquired technologies or products with our current products and technologies; the potential disruption of our ongoing business; the inability to retain key technical, sales and managerial personnel; the inability of management to maximize our financial and strategic position through the successful integration of acquired businesses; the risk that revenues from acquired companies, products and technologies do not meet our expectations; and decreases in reported earnings as a result of charges for in-process research and development and amortization of acquired intangible assets.

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

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

Unanticipated changes in our effective tax rates or exposure to additional income tax liabilities could affect our profitability.

We carry out our business operations through legal entities in the US and multiple foreign jurisdictions. These operations require that we file corporate income tax returns that are subject to US, State and foreign tax laws. The US, State and foreign tax liabilities are determined, in part, by the amount of operating profit generated in these different taxing jurisdictions. Our effective tax rate and net earnings could be adversely affected by changes in the mix of operating profits generated in countries with higher statutory tax rates. We are also required to evaluate the realizability of our deferred tax assets. This evaluation requires that our management assess the positive and negative evidence regarding sources of future taxable income. If management’s assessment regarding the realizability of our deferred tax asset changes or we are presented with additional negative evidence regarding future sources of taxable income, we will be required to increase our valuation allowance, which will negatively impact our effective tax rate and net earnings. We are also subject to routine corporate income tax audits in multiple jurisdictions. Our provision for income taxes includes amounts intended to satisfy income tax assessments that may result from the examination of our corporate tax returns that have been filed in these jurisdictions. The amounts ultimately paid upon resolution of these examinations could be materially different from the amounts included in the provision for income taxes and result in additional tax expense.

Enforcement of our intellectual property rights.

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

Possibility of infringement claims.

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

Risks related to global operations.

We maintain research and development operations in various locations around the world, including in the United States, Israel, Belgium, France and India, and market our products globally. As a result, we face risks from operating as a global concern, including, among others:

• difficulties in staffing and managing international operations;

• inconsistent interpretation of and adherence to our professional conduct policy and code of ethics;

• longer payment cycles;

• seasonal reductions in business activity in Europe;

• increased financial accounting and reporting burdens and complexities;

• adverse tax consequences;

• changes in currency exchange rates;

• loss of proprietary information due to piracy, misappropriation or weaker laws regarding intellectual property protection;

• the need to localize our products;

• political unrest or terrorism, particularly in areas in which we have facilities;

• compliance with a wide variety of complex laws and treaties; and

• licenses, tariffs and other trade barriers.

We maintain a software development and information technology operations office in India, which operates as an extension of our primary development and information technology operations, and we contract with third-party developers in India. As other software companies have done and are continuing to do, we plan to continue to allocate more development and IT resources to India with the expectation of achieving significant efficiencies, including reducing operational costs and permitting an around-the-clock development cycle. To date, the dispute between India and Pakistan involving the Kashmir region has not adversely affected our operations in India. Should we be unable to conduct operations in India in the future, we believe that our business could be temporarily adversely affected.

We conduct substantial development and marketing operations in multiple locations in Israel and, accordingly, we are directly affected by economic, political and military conditions in Israel. Any major hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could materially adversely affect our business, operating results and financial condition. We maintain comprehensive contingency and business continuity plans, and to date, the current conflict in the region and hostilities within Israel have not caused disruption of our operations located in Israel.

Generally, our foreign sales are denominated in our foreign subsidiaries’ local currencies. If these currency exchange rates change unexpectedly, we could have significant gains or losses. The foreign currency to which we currently have the most significant exposure is the Euro. Additionally, fluctuations of the exchange rate of foreign currencies against the U.S. dollar can affect our revenue within those markets, all of which may adversely impact our business, financial condition, operating results, and cash flow. Currently, we use derivative financial instruments to hedge our exposure to fluctuations in currency exchange rates. Such hedging requires us to estimate when transactions will occur and cash will be collected, and we may not be successful in making these estimates. If these estimates are inaccurate, particularly during periods of currency volatility, it could have a materially adverse affect on our business, results of operations or financial positions.

Accounting pronouncements under consideration related to stock-based compensation would reduce our reported earnings and could adversely affect our ability to attract and retain key personnel by reducing the stock-based compensation we are able to provide.

We use stock options and other long-term equity incentives as a fundamental component of our employee compensation packages. We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-term stockholder value and, through the use of vesting, encourage employees to remain with BMC Software. In accounting for our stock option grants using the intrinsic value method under the provisions of Accounting Principles Board Opinion No. 25, we recognize no compensation cost because the exercise price of options granted is equal to the market value of our common stock on the date of grant. The Financial Accounting Standards Board (FASB) has proposed changes to US generally accepted accounting principles that, if implemented, would require us to record charges to earnings for employee stock option grants, which would negatively impact our earnings. For example, as disclosed in Note 5 to the accompanying Condensed Consolidated Financial Statements, recording charges for employee stock options using the fair value method under SFAS No. 123, “Accounting for Stock-Based Compensation,” would have reduced net earnings by $18.1 million and $24.7 million for the quarters ended September 30, 2003 and 2004, respectively, and $43.6 million and $47.0 million for the six months ended September 30, 2003 and 2004, respectively. In addition, the New York Stock Exchange rule requiring stockholder approval for all stock option plans could make it more difficult for us to grant options to employees in the future. To the extent that it becomes more difficult or costly to grant options and/or other stock-based compensation to employees, we may incur increased cash compensation costs or find it difficult to attract, retain and motivate employees, either of which could materially adversely affect our business.

Possible adverse impact of interpretations of existing accounting pronouncements.

On April 1, 1998 and 1999 we adopted AICPA SOP 97-2, “Software Revenue Recognition,” and SOP 98-9 “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions,” respectively. The adoption of these standards did not have a material impact on our financial position or results of operations. Based on our reading and interpretation of these SOPs, we believe that our current sales contract terms and business arrangements have been properly reported. Future interpretations of existing accounting standards or changes in our business practices could result in future changes in our revenue accounting policies that could have a material adverse effect on our business, financial condition and results of operations.

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to a variety of risks, including foreign currency exchange rate fluctuations and changes in the market value of our investments in marketable securities. In the normal course of business, we employ established policies and procedures to manage these risks including the use of derivative instruments. There have been no material changes in our foreign exchange risk management strategy or our marketable securities subsequent to March 31, 2004, therefore our market risk sensitive instruments remain substantially unchanged from the description in our Annual Report on Form 10-K for the year ended March 31, 2004.

ITEM 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of September 30, 2004, we carried out an evaluation, under the supervision of our principal executive officer (CEO) and principal financial officer (CFO), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, our principal executive officer and principal financial officer believe that our disclosure controls and procedures are effective in all material respects in ensuring that material information related to BMC was accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. We are continuing our evaluation of our internal controls versus the standards adopted by the Public Company Accounting Oversight Board. While we have not identified any material weakness or condition in our disclosure controls and procedures that would cause us to consider them ineffective for their intended purpose, in the course of our evaluation of our internal controls and processes, we have identified certain deficiencies, which we are addressing. Areas requiring improvement include: controls around access to the financial system, the account reconciliation process, secondary approval process for journal entries and documentation of existing controls. We have dedicated resources taking appropriate steps to make necessary improvements to the identified areas.

Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed under the Exchange Act is accumulated and communicated to management, including the principal executive and financial officers, as appropriate, to allow timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.

Internal Controls Over Financial Reporting

There were no changes in our internal controls over financial reporting that occurred during the last quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting. However as previously disclosed in our Annual Report on Form 10-K for the year ended March 31, 2004, management, in consultation with Ernst & Young LLP, our independent auditors, identified during the course of the year-end audit a significant internal control deficiency involving inadequate staffing of qualified accounting personnel. We believe this deficiency is temporary and is due to a unique combination of factors, including larger than normal turnover of accounting personnel. Management continues to actively work to strengthen our accounting and finance team to correct the internal control deficiency identified. In addition to the items reported in the Form 10-K and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, the following steps have been taken by the Company as of November 5, 2004:

• our accounting organization has been reorganized with the creation of corporate accounting and business controls departments;

• business controls personnel have been hired for each geographic region;

• accounting duties have been reassigned from other finance departments to corporate accounting;

• open positions for five managers and 13 staff positions have been filled;

• active recruitment and interviewing for remaining open accounting positions continues with the goal of expeditiously filling such vacancies;

• on-the-job training for accounting personnel has occurred and is ongoing, including increased focus on timeliness and accountability; and

• supplemental training for sales personnel, related to revenue recognition and applicable accounting pronouncements, has occurred and is ongoing.

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

On January 29, 2003, we filed a complaint against NetIQ Corporation (NetIQ) in the United States District Court of the Southern District of Texas, Houston Division, alleging that one or more of NetIQ’s software products and their use infringe a valid U.S. patent and that Net IQ infringed one or more trademarks held by us. On August 22, 2003, the Court ordered the case stayed pending arbitration. On September 18, 2003, we filed a Statement of Claim with the American Arbitration Association asserting our claims of patent infringement, subject to our objections to the arbitration proceeding. We are seeking to enjoin NetIQ’s current and future infringement of our patent and to recover compensatory damages and enhanced damages, interest, costs and fees. On November 24, 2003, NetIQ filed a counterclaim with the American Arbitration Association against us alleging patent infringement. We have denied that we infringe any valid claim of the NetIQ patent, which forms the basis of NetIQ’s counterclaim. Discovery is in the very early stages, and a final hearing in the case is not expected before late 2005.

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

ITEM 2. Issuer Purchases of Equity Securities


							(d) Approximate
					(c) Total Number of		Dollar Value of
					Shares Purchased as		Shares that May Yet
	(a) Total Number of		(b) Average Price		Part of Publicly		Be Purchased Under
Period	Shares Purchased		Paid per Share		Announced Program¹		the Program¹
April 1-30, 2004		—	$	—		—	$	307,436,456
May 1-31, 2004		593,000	$	16.94		593,000	$	297,391,036
June 1-30, 2004		573,500	$	17.33		573,500	$	287,460,946
July 1-31, 2004		—	$	—		—	$	287,460,946
August 1-31, 2004		621,000	$	14.67		621,000	$	278,350,876
September 1-30, 2004		1,041,548	$	15.28		1,041,548	$	262,436,023
Total		2,829,048	$	15.91		2,829,048	$	262,436,023

¹In April 2000, our Board of Directors authorized a $500 million stock repurchase program. In July 2002, the Board of Directors increased the authorized stock repurchase program by $500 million. At September 30, 2004, there was approximately $262.4 million remaining in the stock repurchase program. This program does not have an expiration date.

ITEM 4. Submission of Matters to a Vote of Security Holders

At BMC Software’s Annual Meeting of Stockholders held on August 24, 2004 the following proposals were adopted by the margins indicated.


	NUMBER OF SHARES
	VOTED FOR		WITHHELD
1. To elect nine directors of the Company, each to serve until the next annual meeting or until his/her respective successor has been duly elected and qualified.

B. Garland Cupp		170,535,499		24,999,274
Robert E. Beauchamp		189,559,218		5,975,555
Jon E. Barfield		190,349,448		5,185,325
John W. Barter		188,474,297		7,060,476
Meldon K. Gafner		170,547,601		24,987,172
L. W. Gray		170,537,141		24,997,632
Kathleen A. O’Neil		190,348,067		5,186,706
George F. Raymond		188,470,367		7,064,406
Tom C. Tinsley		172,469,557		23,065,216

NUMBER OF SHARES

VOTED FOR

VOTED AGAINST

ABSTAIN

2. To ratify the Board of Directors’ appointment of Ernst & Young LLP as the Company’s independent auditors for the year ending March 31, 2005.

191,920,073

2,534,277

1,080,423

ITEM 5. Other Information

Certain Ernst & Young LLP Non-Audit Services Provided to BMC Subsidiaries in Previous Years

As part of its normal review, the Audit Committee of the Board of Directors carefully evaluates and examines its relationship with its independent registered public accounting firm. In its review of independence, the Audit Committee was made aware that Ernst & Young LLP was considering the impact of certain services that Ernst & Young affiliates had performed for BMC subsidiaries in China. These services were discontinued in April 2002, and the related fees were insignificant. Based on its investigation of the facts, Ernst & Young determined that its independence had not been impaired.

The Audit Committee separately reviewed the relevant facts and circumstances. Based on its review and discussions with Ernst & Young and the Company’s legal advisors, the Audit Committee concluded that Ernst & Young is and has been capable of exercising objective and impartial judgment on all issues encompassed within its engagement as BMC’s independent registered public accounting firm.

ITEM 6. Exhibits and Reports on Form 8-K

(a) Exhibits.


31.1		Certification of the Chief Executive Officer of BMC Software, Inc. pursuant to Section 13a-14(a) of the Securities Exchange Act of 1934.

31.2		Certification of the Chief Financial Officer of BMC Software, Inc. pursuant to Section 13a-14(a) of the Securities Exchange Act of 1934.

32.1		Certification of the Chief Executive Officer of BMC Software, Inc. pursuant to Section 13a-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.

32.2		Certification of the Chief Financial Officer of BMC Software, Inc. pursuant to Section 13a-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.

(b) Reports on Form 8-K.

On July 7, 2004, BMC Software filed a Current Report on Form 8-K, dated July 7, 2004, furnishing under Item 12 its news release to report preliminary historical financial results for the quarter ended June 30, 2004.

On July 27, 2004, BMC Software filed a Current Report on Form 8-K, dated July 27, 2004, furnishing under Item 12 its news release to report its historical financial results for the quarter ended June 30, 2004.

On August 9, 2004, BMC Software filed a Current Report on Form 8-K, dated August 9, 2004, furnishing under Item 12 its news release to report adjusted historical financial results for the quarter ended June 30, 2004.

On September 8, 2004, BMC Software filed a Current Report on Form 8-K, dated September 8, 2004, reporting under Item 5.02 the resignation of John W. Cox and the appointment of Leonard E. Travis as its Chief Accounting Officer.


	Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2004 and September 30, 2004 (Unaudited)		3
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three months and six months ended September 30, 2003 and 2004 (Unaudited)		4
Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2003 and 2004 (Unaudited)		5
Notes to Condensed Consolidated Financial Statements (Unaudited)		6
Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition		12
Item 3. Quantitative and Qualitative Disclosures about Market Risk		31
Item 4. Controls and Procedures		31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings		33
Item 2. Issuer Purchases of Equity Securities		33
Item 4. Submission of Matters to a Vote of Security Holders		34
Item 5. Other Information		34
Item 6. Exhibits and Reports on Form 8-K		35
Signatures		36
Certification of CEO pursuant to Section 13a-14a
Certification of CFO pursuant to Section 13a-14a
Certification of CEO pursuant to Section 13a-14b
Certification of CFO pursuant to Section 13a-14b


	BMC SOFTWARE, INC.
	By:	/s/ Robert E. Beauchamp Robert E. Beauchamp President and Chief Executive Officer
November 9, 2004
	By:	/s/ George W. Harrington George W. Harrington Senior Vice President and Chief Financial Officer
November 9, 2004

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	•		For the six months ended September 30, 2004, the increase in net earnings (loss) after non-cash adjustments is primarily due to the increase in net earnings for the period over the net loss reported in the prior year period.

	•		Working capital decreased from March 31, 2004 to September 30, 2004 primarily due to the use of cash for the Marimba acquisition and the purchase of long-term marketable securities.

	•		As discussed above under Settlement of Litigation, we expect to make a one-time cash payment of $11.3 million to Nastel during the quarter ending December 31, 2004.

	•		We continue to finance our operations primarily through funds generated from operations. Our primary source of cash is the sale of our software licenses, software maintenance, enhancement and support and professional services. We believe that our existing cash balances and funds generated from operating and investing activities will be sufficient to meet our liquidity requirements for the foreseeable future. However, we have a history of acquiring companies. If we were to make a significant acquisition in the future, we might find it advantageous to utilize third-party financing sources based on factors such as our then available cash and its source (i.e., cash held in the United States vs. international), the cost of financing and our internal cost of capital.

	•		The main source of cash from investing activities is the proceeds from maturities/sales of marketable securities.

	•		Cash paid for technology acquisitions and other investments, net of cash acquired, for the six months ended September 30, 2004 includes $203.4 million, including direct costs of the transaction, for our purchase of Marimba.

	•		The main components of other cash used in investing activities are purchases of property and equipment, primarily computer hardware and software, and capitalization of software development costs.

	•		There were no borrowings during the six months ended September 30, 2003 and 2004, and the main use of cash for financing activities was the acquisition of treasury stock. During the six months ended September 30, 2004, approximately 2.8 million shares of treasury stock were purchased. We plan to be consistent with our historical treasury stock purchase practices, subject to market conditions, other possible uses of our cash and our domestic liquidity position.

	•		The exercise of stock options was the primary source of cash in financing activities.

	•		Capital lease obligations of $16.7 million and $4.2 million were incurred during the six months ended September 30, 2003 and 2004, respectively, for computer hardware.