UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

(Mark One)

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

For the quarterly period ended December 31, 2004

OR

o	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.

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 þ No o

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

     As of February 7, 2005, there were outstanding 221,530,103 shares of Common Stock, par value $.01, of the registrant.

BMC SOFTWARE, INC. AND SUBSIDIARIES
QUARTER ENDED DECEMBER 31, 2004

INDEX

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

BMC SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions)

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

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BMC SOFTWARE, INC. AND SUBSIDIARIES

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

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

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BMC SOFTWARE, INC. AND SUBSIDIARIES

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

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

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BMC SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) Basis of Presentation

     The accompanying unaudited 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.

     These 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 December 31, 2003 and 2004, the treasury stock method effect of 27.8 million and 13.1 million weighted options, respectively, has been excluded from the calculation of diluted EPS, as they are anti-dilutive. For the nine-month periods ended December 31, 2003 and 2004, the treasury stock method effect of 28.9 million and 24.0 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 nine months ended December 31, 2003 and 2004:

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(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 $20.9 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 $8.0 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 for the options that ultimately vest.

     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 are intended to strengthen the Company’s Business Service Management (BSM)-related offerings.

     The aggregate purchase price was $255.3 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 as of the date of acquisition.

     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 $152.9 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 nine months ended December 31, 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 for the three months and nine months ended December 31, 2003, includes material non-recurring charges of $89.6 million and $124.0 million, respectively, related to severance and facilities costs as a result of exit activities during those periods. The pro

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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.

     The Company completed the acquisition of Viadyne Corporation during the second quarter ended September 30, 2004. The aggregate purchase price for this transaction was $5.9 million in cash, including direct deal costs, and was allocated as follows: $2.7 million to acquired technology, $0.8 million to goodwill, $0.2 million to acquired research and development, $1.1 million to other intangibles and $1.1 million to tangible assets acquired, net of liabilities assumed.

     During the third quarter ended December 31, 2004, the Company completed an immaterial acquisition with an aggregate purchase price of $3.0 million in cash, which was allocated to acquired technology.

(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 during fiscal 2005 to clarify accountability and increase organizational effectiveness. The amounts reported below for the three months and nine months ended December 31, 2003 and 2004, reflect these changes in the composition of the Company’s business segments.

     For the Mainframe Management, Distributed Systems 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 Service Management segment is measured based on its direct controllable research and development (R&D), marketing and professional services costs and the costs of the acquired Marimba sales force. Segment performance for the Identity Management segment is measured based on its direct controllable research and development (R&D) and marketing 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 expenses and certain support costs, the effect of software development cost capitalization and amortization, other selling and marketing expenses, 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.

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(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 issued during the nine month periods ended December 31, 2003 and 2004 have been granted with exercise prices equal to the quoted market price on 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 $20.9 million related to the replacement options issued, of which $8.0 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 for the options that ultimately vest. 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 December 31, 2003 and 2004, the Company recorded compensation expense of $0.5 million and $0.4 million, respectively, for restricted stock grants. For the nine months ended December 31, 2003 and 2004, the Company recorded compensation expense of $1.5 million and $1.0 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 nine months ended December 31, 2004, the Company recorded compensation expense of $1.1 million and $1.9 million, respectively, related to these options.

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     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 (in millions, except per share data):

     In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R), “Share-Based Payment,” which is a revision of SFAS No. 123. SFAS No. 123(R) supersedes APB Opinion No. 25 and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. Pro forma disclosure is no longer an alternative. SFAS No. 123(R) permits adoption using one of two methods: (1) a “modified prospective” method in which compensation cost is recognized beginning on the effective date based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and based on SFAS No. 123 for all awards granted to employees prior to the effective date that remain unvested on the effective date or (2) a “modified retrospective” method which includes the requirements of the modified prospective method, but also permits entities to restate all periods presented or prior interim periods of the year of adoption based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures. The Company is currently evaluating those two methods. The provisions of SFAS No. 123(R) are effective for the first interim or annual period beginning after June 15, 2005. The Company will adopt SFAS No. 123(R) as of the beginning of the three-month period ending September 30, 2005, its second quarter of fiscal 2006.

     As permitted by SFAS No. 123, the Company currently accounts for share-based payments to employees using APB Opinion No. 25’s intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options, as the exercise prices of options granted are generally equal to the quoted market price of the Company’s common stock on the date of grant. Accordingly, the adoption of SFAS No. 123(R)‘s fair value method will have a significant impact on the Company’s results of operations. The impact of adoption of SFAS No. 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the Company adopted SFAS No. 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net earnings (loss) and earnings (loss) per share above and in Note 1 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended March 31, 2004. SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. In general, this requirement would reduce net operating cash flows and increase net financing cash flows in periods after adoption; however, the Company has not recognized any such tax benefits for the years ended March 31, 2003 and 2004, and for the nine months ended December 31, 2004. The Company cannot estimate what the tax benefit amounts will be in the future (because they depend on, among other things, when employees exercise stock options).

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(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 nine months ended December 31, 2003 are reflected in the accompanying Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) as follows:

     As of December 31, 2004, $46.7 million of severance and facilities costs related to actions completed under the plan remained accrued for payment in future periods, as follows:

     The amounts accrued at December 31, 2004 related to facilities costs represent the remaining fair value of lease obligations for 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 December 31, 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 nine months ended December 31, 2004 is $13.1 million and $37.9 million, respectively, resulting in effective tax rates of 26% and 39%, respectively. The income tax provision for the nine months ended December 31, 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.

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     On October 22, 2004, President Bush signed the American Jobs Creation Act of 2004, which provides for a special one-time tax deduction of 85% of certain foreign earnings that are repatriated. The Company would be eligible for this deduction on a repatriation in either fiscal 2005 or fiscal 2006. The decision whether to repatriate eligible funds involves complex analysis and, at this time, is subject to considerable interpretation and uncertainty. On January 13, 2005, the Department of the Treasury issued the first of an expected series of notices to provide guidance on the repatriation legislation that is intended to eliminate much of this uncertainty. As of the filing of this Quarterly Report, the Company is not yet in a position to decide on whether, and to what extent, it might repatriate foreign earnings that are currently indefinitely reinvested. Based on the Company’s analysis to date, however, it is reasonably possible that of its total unremitted foreign earnings it may repatriate between $0 and $735.0 million, resulting in an incremental tax expense between $0 and $42.0 million. The Company expects to complete its evaluation of this potential one-time earnings repatriation during calendar 2005.

(8) Trade Finance Receivables

     As discussed in Note 4 to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended March 31, 2004, prior to fiscal 2004, the Company securitized trade finance receivables from customers with investment-grade credit ratings through two conduit entities sponsored by third-party financial institutions. In April 2004, one of the conduit entities sold its interests in the Company’s outstanding securitized finance receivables to the other conduit entity, such that the senior interests in all of the Company’s outstanding securitized finance receivables were held by one conduit entity. In December 2004, the Company purchased the senior interests from the conduit entity at fair value, effectively terminating its securitization arrangements. The Company simultaneously transferred the outstanding finance receivables that had previously been securitized to an unaffiliated financial institution on a non-recourse basis through its existing financial subsidiary. This transfer was recorded as a sale in accordance with SFAS No. 140, and the Company realized a gain of $8.0 million representing the excess of proceeds over the estimated fair value recorded for the previously subordinated interests. The gain is included in Interest and Other Income, net for the three months and nine months ended December 31, 2004 in the accompanying Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). The Company does not expect to securitize trade finance receivables in the future but will continue to transfer such receivables on a non-recourse basis through individual transfers.

     Prior to the purchase of previously securitized finance receivables discussed above, the Company utilized interest rate swaps with the objective of minimizing its interest rate exposure on the retained subordinate interests to immaterial levels. Upon the purchase of the previously securitized receivables, the Company settled its outstanding interest rate swaps.

(9) Subsequent Event

     On January 21, 2005, the Company acquired all of the outstanding shares of Calendra SA (Calendra) for approximately $33.0 million in cash. Calendra’s results will be included in the Company’s consolidated financial statements as of the acquisition date as part of the Identity Management segment. Calendra focuses on workflow and directory management solutions that provide improved communication, increased productivity and increased return on investment for identity management solutions.

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.

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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 nine months ended December 31, 2004, our diluted earnings per share were $0.16 and $0.27 per share, respectively, as compared to diluted losses of $0.20 and $0.28 per share, respectively, for the same periods in the prior year. This improvement is primarily related to higher operating expenses during the prior year periods as a result of our restructuring activities in that year and increased maintenance and professional services revenues and other income during the quarter and nine months ended December 31, 2004. Our license revenues during the quarter and nine months ended December 31, 2004 were down slightly compared to the same periods of fiscal 2004. We maintained a strong balance sheet with cash, cash equivalents and marketable securities balances at December 31, 2004 of $1.1 billion, and we generated $227.7 million in cash flows from operations for the nine months ended December 31, 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 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 nine months ended December 31, 2004.

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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.