10-Q

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 June 30, 2004

OR

[  ] 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 [ü] 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 August 5, 2004, there were outstanding 223,083,206 shares of Common Stock, par value $.01, of the registrant.

BMC SOFTWARE, INC. AND SUBSIDIARIES
QUARTER ENDED JUNE 30, 2004

INDEX

	Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2004 and June 30, 2004 (Unaudited)		3
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three months ended June 30, 2003 and 2004 (Unaudited)		4
Condensed Consolidated Statements of Cash Flows for the three months ended June 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		10
Item 3. Quantitative and Qualitative Disclosures about Market Risk		27
Item 4. Controls and Procedures		28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings		29
Item 6. Exhibits and Reports on Form 8-K		30
Signatures		31
Short-Term Incentive Performance Award Program
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

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

BMC SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions)

	March 31,			June 30,
	2004			2004
				(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	612.3		$	789.2
Marketable securities		296.6			169.8
Trade accounts receivable, net		172.6			120.7
Current trade finance receivables, net		175.5			146.0
Other current assets		167.9			161.2
Total current assets		1,424.9			1,386.9
Property and equipment, net		396.0			399.9
Software development costs and related assets, net		138.9			133.7
Long-term marketable securities		304.1			277.4
Long-term trade finance receivables, net		158.7			122.8
Acquired technology, net		80.3			71.1
Goodwill, net		383.6			384.7
Intangible assets, net		56.2			52.0
Other long-term assets		102.1			105.3
	$	3,044.8		$	2,933.8
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Trade accounts payable	$	39.2		$	23.2
Accrued liabilities		279.3			213.7
Current portion of deferred revenue		668.4			663.1
Total current liabilities		986.9			900.0
Long-term deferred revenue		733.2			731.5
Other long-term liabilities		109.5			97.5
Total liabilities		1,829.6			1,729.0
Commitments and contingencies
Stockholders’ equity:
Preferred stock		—			—
Common stock		2.5			2.5
Additional paid-in capital		537.2			536.4
Retained earnings		1,108.8			1,119.5
Accumulated other comprehensive income (loss)		(10.7	)		(16.9	)
		1,637.8			1,641.5
Less treasury stock, at cost		(421.7	)		(435.1	)
Less unearned portion of restricted stock compensation		(0.9	)		(1.6	)
Total stockholders’ equity		1,215.2			1,204.8
	$	3,044.8		$	2,933.8

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

3

BMC SOFTWARE, INC. AND SUBSIDIARIES

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

	Three Months Ended
	June 30,
	2003			2004
Revenues:
License	$	107.6		$	100.3
Maintenance		183.5			204.8
Professional services		18.8			20.9
Total revenues		309.9			326.0
Operating expenses:
Selling and marketing expenses		137.9			124.7
Research, development and support expenses		127.3			109.3
Cost of professional services		19.0			20.5
General and administrative expenses		37.3			42.7
Amortization of acquired technology and intangibles		15.6			16.1
Total operating expenses		337.1			313.3
Operating income (loss)		(27.2	)		12.7
Interest and other income, net		21.6			19.7
Gain (loss) on marketable securities and other investments		(0.8	)		(2.1	)
Other income, net		20.8			17.6
Earnings (loss) before income taxes		(6.4	)		30.3
Income tax provision (benefit)		(0.3	)		19.6
Net earnings (loss)	$	(6.1	)	$	10.7
Basic earnings (loss) per share	$	(0.03	)	$	0.05
Diluted earnings (loss) per share	$	(0.03	)	$	0.05
Shares used in computing basic earnings (loss) per share		229.6			223.1
Shares used in computing diluted earnings (loss) per share		229.6			225.1
Comprehensive income (loss):
Net earnings (loss)	$	(6.1	)	$	10.7
Foreign currency translation adjustment		12.9			(0.4	)
Unrealized gain (loss) on securities available for sale:
Unrealized gain (loss), net of taxes of $1.0 and $4.0		1.8			(7.5	)
Realized (gain) loss included in net earnings (loss), net of taxes of $0.3 and $0.7		0.6			1.4
		2.4			(6.1	)
Unrealized gain (loss) on derivative instruments:
Unrealized loss, net of taxes of $0.9 and $0		(1.7	)		—
Realized loss included in net earnings (loss), net of taxes of $0.3 and $0.1		0.6			0.3
		(1.1	)		0.3
Comprehensive income (loss)	$	8.1		$	4.5

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

4

BMC SOFTWARE, INC. AND SUBSIDIARIES

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

	Three Months Ended
	June 30,
	2003			2004
Cash flows from operating activities:
Net earnings (loss)	$	(6.1	)	$	10.7
Adjustments to reconcile net earnings (loss) to net cash provided by operating activities:
Depreciation and amortization		57.7			49.5
(Gain) loss on marketable securities		0.8			2.1
Earned portion of restricted stock compensation		0.6			0.3
(Increase) decrease in finance receivables		91.3			65.9
Increase (decrease) in payables to third-party financing institutions for finance receivables		(35.1	)		(18.3	)
Net change in trade receivables, payables, deferred revenue and other components of working capital		14.8			(20.1	)
Net cash provided by operating activities		124.0			90.1
Cash flows from investing activities:
Cash paid for technology acquisitions and other investments, net of cash acquired		(6.1	)		(4.8	)
Adjustment of cash paid for Remedy acquisition		7.2			—
Purchases of marketable securities		(163.2	)		(5.1	)
Maturities of/proceeds from sales of marketable securities		49.1			146.4
Purchases of property and equipment		(12.7	)		(16.8	)
Capitalization of software development costs and related assets		(15.0	)		(14.2	)
Net cash provided by (used in) investing activities		(140.7	)		105.5
Cash flows from financing activities:
Payments on capital leases		—			(1.0	)
Stock options exercised and other		1.3			4.9
Treasury stock acquired		(60.0	)		(20.0	)
Net cash used in financing activities		(58.7	)		(16.1	)
Effect of exchange rate changes on cash		3.4			(2.6	)
Net change in cash and cash equivalents		(72.0	)		176.9
Cash and cash equivalents, beginning of period		500.1			612.3
Cash and cash equivalents, end of period	$	428.1		$	789.2
Supplemental disclosure of cash flow information:
Cash paid (refunded) for income taxes	$	0.6		$	3.9
Liabilities assumed in acquisitions	$	0.2		$	—
Receivable for disposal of technology	$	2.0		$	—

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

5

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. Certain amounts previously reported have been reclassified to provide comparability among the periods presented or reflect recent pronouncements.

     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 June 30, 2003 and 2004, the treasury stock method effect of 31.1 million and 13.8 million weighted options, respectively, had 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 ended June 30, 2003 and 2004, respectively:

	Three Months Ended
	June 30,
	2003			2004
	(In millions,
	except per share data)
Basic earnings (loss) per share:
Net earnings (loss)	$	(6.1	)	$	10.7
Weighted average number of common shares		229.6			223.1
Basic earnings (loss) per share	$	(0.03	)	$	0.05
Diluted earnings (loss) per share:
Net earnings (loss)	$	(6.1	)	$	10.7
Weighted average number of common shares		229.6			223.1
Incremental shares from assumed conversions of stock options and other		—			2.0
Adjusted weighted average number of common shares		229.6			225.1
Diluted earnings (loss) per share	$	(0.03	)	$	0.05

6

(3) Segment Reporting

     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, which includes the Remedy® and Magic products; and Identity Management. Profitability is measured at the product category level. Through March 31, 2004, BMC’s management reviewed the results of the Company’s software business by different product categories and has recently made changes to the product categories to increase organizational effectiveness. The descriptive names selected for each product category are representative of the solutions developed and provide clarity about each product category’s focus area. The amounts reported below for the three months ended June 30, 2003 and 2004, reflect this change in the composition of the Company’s product categories.

     For the Mainframe Management, Distributed Systems Management, Service Management and Professional Services product categories, performance is measured based on contribution margin, reflecting only the direct controllable expenses of the product categories. Performance for the Identity Management product category 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. Assets and liabilities are not accounted for by product category.

			Distributed
	Mainframe		Systems		Service		Identity					Professional		Indirect
Quarter Ended June 30, 2003	Management		Management		Management		Management			Other		Services		Costs			Consolidated
	(In millions)
Revenues:
License	$	35.6	$	47.7	$	20.8	$	3.3		$	0.2	$	—	$	—		$	107.6
Maintenance		78.2		70.7		29.8		4.1			0.7		—		—			183.5
Professional services		—		—		—		—			—		18.8		—			18.8
Total revenues		113.8		118.4		50.6		7.4			0.9		18.8		—			309.9
R&D and support expenses		21.0		47.8		14.1		7.5			—		—		36.9			127.3
Cost of services		—		—		—		1.0			—		18.0		—			19.0
		92.8		70.6		36.5		(1.1	)		0.9		0.8		(36.9	)		163.6
Selling and marketing expenses		—		—		—		2.7			—		—		135.2			137.9
Contribution margin	$	92.8	$	70.6	$	36.5	$	(3.8	)	$	0.9	$	0.8		(172.1	)	$	25.7
General and administrative expenses																		37.3
Operating margin																		(11.6	)
Amortization of acquired technology and intangibles																		15.6
Other income, net																		20.8
Consolidated loss before taxes																	$	(6.4	)

			Distributed
	Mainframe		Systems		Service		Identity					Professional		Indirect
Quarter Ended June 30, 2004	Management		Management		Management		Management			Other		Services		Costs			Consolidated
	(In millions)
Revenues:
License	$	34.7	$	36.0	$	28.2	$	1.4		$	—	$	—	$	—		$	100.3
Maintenance		77.7		77.3		46.1		3.7			—		—		—			204.8
Professional services		—		—		—		—			—		20.9		—			20.9
Total revenues		112.4		113.3		74.3		5.1			—		20.9		—			326.0
R&D and support expenses		21.8		39.0		16.0		6.0			—		—		26.5			109.3
Cost of services		—		—		—		0.5			—		20.0		—			20.5
		90.6		74.3		58.3		(1.4	)		—		0.9		(26.5	)		196.2
Selling and marketing expenses		—		—		—		2.4			—		—		122.3			124.7
Contribution margin	$	90.6	$	74.3	$	58.3	$	(3.8	)	$	—	$	0.9		(148.8	)	$	71.5
General and administrative expenses																		42.7
Operating margin																		28.8
Amortization of acquired technology and intangibles																		16.1
Other income, net																		17.6
Consolidated income before taxes																	$	30.3

7

(4) Stock Incentive Plans

     The Company has adopted numerous stock plans that provide for the grant of 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. The restricted stock is subject to transfer restrictions that lapse over one to four years. The Company also has adopted 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 June 30, 2003 and 2004, the Company recorded compensation expense of $0.6 million and $0.3 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.

     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
		June 30,
		2003			2004
		(In millions, except
		per share data)
Net earnings (loss):	As Reported	$	(6.1	)	$	10.7
Add stock-based employee compensation expense included in net earnings (loss) as reported, net of related tax effects			0.4			0.2
Deduct stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects			(25.9	)		(16.2	)
	Pro Forma	$	(31.6	)	$	(5.3	)
Basic earnings (loss) per share:	As Reported	$	(0.03	)	$	0.05
	Pro Forma	$	(0.14	)	$	(0.02	)
Diluted earnings (loss) per share:	As Reported	$	(0.03	)	$	0.05
	Pro Forma	$	(0.14	)	$	(0.02	)

8

(5) Guarantees

     FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45) requires certain guarantees to be recorded at fair value and requires a guarantor to make disclosures, even when the likelihood of making any payments under the guarantee is remote. For those guarantees and indemnifications that do not fall within the initial recognition and measurement requirements of FIN 45, the Company must continue to monitor the conditions that are subject to the guarantees and indemnifications, as required under existing generally accepted accounting principles, to identify if a loss has been incurred. If the Company determines that it is probable that a loss has been incurred, any such estimable loss would be recognized. The initial recognition and measurement requirements do not apply to the Company’s product warranties or to the provisions contained in the majority of the Company’s software license agreements that indemnify licensees of the Company’s software from damages and costs resulting from claims alleging that the Company’s software infringes the intellectual property rights of a third party. The Company has historically received only a limited number of requests for payment under these provisions and has not been required to make material payments pursuant to these provisions. The Company has not identified any losses that are probable under these provisions and, accordingly, the Company has not recorded a liability related to these indemnification provisions.

(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. The workforce reduction was across all functions and geographies and affected employees were provided separation packages. As a global enterprise, the Company has been expanding its operations for a number of years in attractive labor markets, including India and Israel. The Company’s fiscal year 2004 actions have, to an extent, accelerated this trend. The Company has exited leases in certain locations, reduced the square footage required to operate those locations and relocated some operations to lower cost facilities. These relocation efforts were completed as of December 31, 2003.

     As of June 30, 2004, $57.1 million of severance and facilities costs related to actions completed under the plan remained accrued for payment in future periods, as follows:

	Balance at									Cash Payments			Balance at
	March 31,		Charged to				Adjustments			Net of Sublease			June 30,
	2004		Expense		Accretion		To Estimates			Income			2004
					(In millions)
Severance and related costs	$	3.9	$	—	$	—	$	0.8		$	(2.1	)	$	2.6
Facilities costs		64.7		—		0.6		(1.9	)		(8.9	)		54.5
Total accrual	$	68.6	$	—	$	0.6	$	(1.1	)	$	(11.0	)	$	57.1

     The amounts accrued at June 30, 2004 related to facilities costs represent the fair value of lease obligations related to exited locations, net of estimated sublease income that could be reasonably obtained in the future and will be paid out over the remaining lives of the applicable lease terms, the last of which ends in fiscal 2011. The Company does not expect any significant additional severance or facilities charges subsequent to June 30, 2004 other than potential adjustments to lease accruals based on actual subleases differing from the estimates. The Company expects to pay out all amounts accrued for severance and related costs in fiscal 2005. Accretion (the increase in present value amounts that have been discounted) and adjustments to original estimates are included in operating expenses.

9

(7) Income Taxes

     Income tax expense for the three months ended June 30, 2004 is $19.6 million resulting in an effective tax rate of 65%. Included in income tax expense for the quarter is approximately $11.1 million intended to satisfy income tax assessments that may result from the examination of the Company’s corporate tax returns that have been filed in domestic and foreign jurisdictions and to increase the valuation allowance for certain deferred tax assets. Excluding these items, the effective tax rate for the three months ended June 30, 2004 is 28%.

(8) Subsequent Event

     The Company completed its acquisition of Marimba, Inc. (Marimba) on July 15, 2004 for the purchase price of approximately $255 million, including direct costs of the transaction. The results related to this acquisition will be included in the Service Management product category.

(9) Litigation

     On July 31, 2001, Nastel Technologies, Inc. (Nastel) filed a complaint in arbitration alleging breach of licensing agreement by the Company, copyright infringement, and theft of trade secrets. The Company filed a counterclaim against Nastel for reimbursement of overpaid royalties based upon conflicting licensing agreements. The Company believes it has meritorious defenses for the claims asserted against it. The parties have completed the arbitration hearing and have submitted post-hearing briefing to the arbitration panel. A ruling in this matter is expected in the second fiscal quarter of 2005. The Company’s management believes that it is reasonably possible that a judgment will be ordered against the Company in this case; however, the amount of any such judgment is not estimable.

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 ended June 30, 2004, we earned $0.05 per share as compared to a loss of $0.03 per share for the same quarter in the prior year. This improvement is primarily related to decreased operating expenses as a result of last year’s restructuring. Although our expense management efforts are paying off, our license revenue performance during the quarter did not meet our expectations and declined 7% compared to the first quarter of fiscal 2004. We maintained a strong balance sheet with cash, cash equivalents and marketable securities balances at June 30, 2004 of $1.2 billion, and we generated $90.1 million in cash flows from operations.

10

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 relationship 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 MD&A.

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 where such policies affect our reported and expected financial results. Our critical accounting polices have not changed in any material respect, nor have we adopted any new critical accounting policies during the three months ended June 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 comparisons of financial results are not necessarily indicative of future results.

	Percentage of
	Total Revenues
	Three Months Ended
	June 30,
	2003			2004
Revenues:
License		34.7	%		30.8	%
Maintenance		59.2			62.8
Professional services		6.1			6.4
Total revenues		100.0			100.0
Operating expenses:
Selling and marketing expenses		44.5			38.3
Research, development and support expenses		41.1			33.5
Cost of professional services		6.1			6.3
General and administrative expenses		12.0			13.1
Amortization of acquired technology and intangibles		5.0			4.9
Total operating expenses		108.7			96.1
Operating income (loss)		(8.7	)		3.9
Interest and other income, net		7.0			6.0
Gain (loss) on marketable securities and other investments		(0.3	)		(0.6	)
Other income, net		6.7			5.4
Earnings (loss) before income taxes		(2.0	)		9.3
Income tax provision (benefit)		—			6.0
Net earnings (loss)		(2.0	)%		3.3	%

Revenues

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

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	Three Months Ended
	June 30,
	2003		2004		Change
	(In millions)
License:
Domestic	$	43.4	$	46.4		6.9	%
International		64.2		53.9		(16.0	)%
Total license revenues		107.6		100.3		(6.8	)%
Maintenance:
Domestic		105.7		115.0		8.8	%
International		77.8		89.8		15.4	%
Total maintenance revenues.		183.5		204.8		11.6	%
Professional Services:
Domestic		9.1		10.0		9.9	%
International		9.7		10.9		12.4	%
Total professional services		18.8		20.9		11.2	%
Total revenues	$	309.9	$	326.0		5.2	%

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     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 for the quarter ended June 30, 2004, decreased 7% compared to the same period last year. Weakness in IT spending and customer procurement process slowdowns resulted in the decline in license revenues. License bookings were similarly affected. The number of license transactions over $1 million during the quarter decreased to nine from 16 in the prior year period. In the quarter ended June 30, 2004, there were no license transactions greater than $5 million. The total license value of these nine transactions was $17 million, compared to $30 million for the 16 transactions in the comparable prior year period.

     For the periods ended June 30, 2003 and 2004, our recognized revenues were impacted by the changes in our deferred license revenue balance as follows (in millions):

	Three Months Ended
	June 30,
	2003			2004
Deferrals of license revenue	$	(21.9	)	$	(22.1	)
Recognition from deferred license revenue		23.7			38.8
Net impact on recognized license revenue	$	1.8		$	16.7
Deferred license revenue balance at end of quarter	$	216.3		$	335.6

     We expect that our deferred license revenue will grow in fiscal 2005 based on increased customer requests for contractual terms that result in deferral of revenue and our recent initiative to ensure our customers understand the flexibility that we offer. 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 revenue 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 revenue 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 June 30, 2004, the average remaining life of the deferred license revenue balance was approximately three and one half years.

     Our domestic operations generated 40% and 46% of license revenues in the quarters ended June 30, 2003 and 2004, respectively. Domestic license revenues for the quarter ended June 30, 2004 increased 7% compared to the comparable period in the prior fiscal year. For the quarter ended June 30, 2004, the improvement from the prior year is due to the increase in recognition from deferred license revenue as noted in the table above. The IT spending environment in the domestic region remains challenging. International license revenues represented 60% and 54% of license revenues for the quarters ended June 30, 2003 and 2004, respectively. International license revenues for the quarter ended June 30, 2004 decreased 16% compared to the same period last year. Foreign currency exchange rate changes resulted in an increase in international license revenue of 3% for the quarter ended June 30, 2004, net of hedging. Excluding this currency impact, international license revenues decreased 19% compared to the quarter ended June 30, 2003.

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     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. 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 12% for the quarter ended June 30, 2004, over the comparable prior year period, primarily as a result of the additional maintenance revenue associated with the Remedy and Magic products and the continuing growth in the base of installed products and the processing capacity on which they run. Maintenance fees increase as 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 the reduced maintenance percentages for long-term contracts discussed above and the decline in our license revenues, have led to lower growth rates for our maintenance revenue excluding the Remedy and Magic products. Further declines in our license revenue and/or increased discounting could lead to declines in our maintenance revenues. 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.

     Product Line Revenues

	Three Months Ended
	June 30,
	2003		2004		Change
	(In millions)
Mainframe Management:
Mainframe Data Management	$	82.9	$	85.5		3.1	%
MAINVIEW		30.9		26.9		(12.9	)%
		113.8		112.4		(1.2	)%
Distributed Systems Management:
PATROL		61.6		56.2		(8.8	)%
Distributed Systems Data Management		25.9		26.6		2.7	%
Scheduling & Output Management		30.9		30.5		(1.3	)%
		118.4		113.3		(4.3	)%
Service Management		50.6		74.3		46.8	%
Identity Management		7.4		5.1		(31.1	)%
Other		0.9		—		(100.0	)%
Total license & maintenance revenues	$	291.1	$	305.1		4.8	%

     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% and 37% of our total software revenues for the quarters ended June 30, 2003 and 2004, respectively. Total software revenues for this product category declined 1% in the quarter ended June 30, 2004, from the same period in the prior year. The overall decrease for the quarter ended June 30, 2004 was primarily due to the decrease in both 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. This decrease was partially offset by increased license and maintenance revenues for the Mainframe Data Management product line, as the recognition from deferred license revenue for this product line was significantly higher in the quarter ended June 30, 2004 as compared to the prior year period.

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     Distributed Systems Management revenues contributed 41% and 37% of our total software revenues for the quarters ended June 30, 2003 and 2004, respectively. Total software revenues for this product category decreased 4% in the quarter ended June 30, 2004, from the same period in the prior year. Total license bookings for the PATROL and Scheduling and Output Management product lines decreased significantly compared to the prior year period as there were fewer large transactions in the current quarter due to the weakness in IT spending. These decreases in license revenues were partially offset by increases in maintenance revenues primarily from the same two product lines as overall maintenance revenues increased due to the continuing growth in the base of installed products and the processing capacity on which they run.

     Service Management revenues contributed 17% and 24% of our total software revenues for the quarters ended June 30, 2003 and 2004, respectively. Total software revenues for this product category increased 47% in the quarter ended June 30, 2004, from the same period in the prior year as license and maintenance revenues increased 36% and 55%, respectively. The increases were primarily due to the acquisition of Magic Solutions during the fourth quarter of fiscal 2004 and growth of Remedy’s core business.

     Identity Management revenues contributed 3% and 2% of total software revenues for the quarters ended June 30, 2003 and 2004, respectively. Total software revenues for this product category decreased 31% in the quarter ended June 30, 2004 from the same period in the prior year. Identity Management license and maintenance revenues decreased 58% and 10%, respectively, for the quarter ended June 30, 2004, as compared to the comparable prior year period due to more recognition from deferred license revenue in the quarter ended June 30, 2003 as compared to the current year period.

Professional Services Revenues

     Professional services revenues, representing fees from implementation, integration and education services performed during the period increased 11% for the quarter ended June 30, 2004, compared to the prior year period. This increase is primarily the result of several competitive BSM wins.

Operating Expenses

	Three Months Ended
	June 30,
	2003		2004		Change
	(In millions)
Selling and marketing	$	137.9	$	124.7		(9.6	)%
Research, development and support		127.3		109.3		(14.1	)%
Cost of professional services		19.0		20.5		7.9	%
General and administrative		37.3		42.7		14.5	%
Amortization of acquired technology and intangibles		15.6		16.1		3.2	%
Total operating expenses	$	337.1	$	313.3		(7.1	)%

     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. The workforce reduction was across all functions and geographies and affected employees were provided separation packages. As a global enterprise, we have been expanding our operations for a number of years in attractive labor markets, including India and Israel. Our fiscal year 2004 actions have, to an extent, accelerated this trend. We have 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.

     As of June 30, 2004, $57.1 million of severance and facilities costs related to actions completed under the plan remained accrued for payment in future periods, as follows:

	Balance at									Cash Payments			Balance at
	March 31,		Charged to				Adjustments			Net of Sublease			June 30,
	2004		Expense		Accretion		To Estimates			Income			2004
					(In millions)
Severance and related costs	$	3.9	$	—	$	—	$	0.8		$	(2.1	)	$	2.6
Facilities costs		64.7		—		0.6		(1.9	)		(8.9	)		54.5
Total accrual	$	68.6	$	—	$	0.6	$	(1.1	)	$	(11.0	)	$	57.1

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     The amounts accrued at June 30, 2004 related to facilities costs represent the fair value of lease obligations for exited locations, net of estimated sublease income that could be reasonably obtained in the future and will be paid out over the remaining lives of the applicable leases, the last of which ends in fiscal 2011. We do not expect any significant additional severance or facilities charges subsequent to June 30, 2004 other than potential adjustments to lease accruals based on actual subleases differing from the estimates. We expect to pay all amounts accrued for severance and related costs in fiscal 2005. Accretion (the increase in present value of amounts that have been discounted) and adjustments to original estimates are included in operating expenses. We realized operating expense savings in the quarter ended June 30, 2004 of approximately $24 million related to personnel and facilities costs as compared to the prior year period.

     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 45% and 38% of total revenues for the quarters ended June 30, 2003 and 2004, respectively. Selling and marketing expenses decreased 10% for the quarter ended June 30, 2004, as compared to the prior year. The decline is primarily related to decreased personnel expenses, primarily due to our restructuring activities, and reduced bad debt expense related to license billings.

     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 ended June 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 ended June 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
	June 30,
	2003			2004
	(In millions)
Software development and purchased software costs capitalized	$	(15.0	)	$	(14.2	)
Total amortization		23.2			19.4
Net impact on research and development expense	$	8.2		$	5.2
Accelerated amortization included in total amortization above	$	—		$	0.8

     Research, development and support expenses represented 41% and 34% of total revenues for the quarters ended June 30, 2003 and 2004, respectively. Research, development and support expenses decreased 14% in the three months ended June 30, 2004, compared to the same period in the prior year. The decrease is due to a reduction in personnel and facilities costs and personnel growth in lower cost locations, resulting from our restructuring activities, and the net effect of the software capitalization and amortization shown above.

     The decrease in the net effect of software development and purchased software costs is due to the overall reduction in research and development headcount as compared to the comparable prior year period, the development of agentless and channel-ready products that result in less capitalization due to reduced development time and decreased amortization as mature products become fully amortized.

     Cost of Professional Services

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     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% of total revenues for both quarters ended June 30, 2003 and 2004, respectively. Cost of professional services increased 8% for the quarter ended June 30, 2004 compared to the prior year quarter due to increased third-party implementation services and was partially offset by decreased personnel costs due to our restructuring activities and decreased travel costs.

     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 12% and 13% of total revenues in the quarters ended June 30, 2003 and 2004, respectively. These expenses increased 15% for the quarter ended June 30, 2004, compared to the same period 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, greater losses related to the impact of foreign currency exchange rate changes. These increases more than offset decreased depreciation on leasehold improvements related to our restructuring activities.

     Amortization of Acquired Technology and Intangibles

     Under the purchase accounting method for certain of our acquisitions, portions of the purchase prices were allocated to acquired software and other intangible assets. We are amortizing these intangibles over three-year periods, which reflect the estimated useful lives of the respective assets. The increase in amortization expense for the quarter ended June 30, 2004 is due to the acquisition of Magic in the fourth quarter of fiscal 2004.

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 ended June 30, 2004, other income, net was $17.6 million, reflecting a decrease of $3.2 million from the same period of fiscal 2004. The decrease in other income, net for the three months is primarily due to a loss on the sale of investments in the first quarter of fiscal 2005.

Income Tax Provision (Benefit)

     For the quarter ended June 30, 2004, our income tax expense was $19.6 million, compared to a benefit of $0.3 million for the same period in the prior year. Included in income tax expense for the quarter ended June 30, 2004 is an accrual of approximately $11.1 million 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. Excluding these accruals, our effective tax rate for the three months ended June 30, 2004 was 28% as compared to 5% for the comparable prior year period. The low effective tax rate for the quarter ended June 30, 2003 results because of the impact of non-deductible amortization expense during a period with a net pre-tax loss.

     During the quarter ended June 30, 2004, we and the Internal Revenue Service Appeals Division resolved our income tax audits for the fiscal years ended March 31, 1998 and 1999. The settlement 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 recently filed our protest letter and formally requested a conference with IRS Appeals to begin resolution of the issues in dispute. 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.

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

17

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 EITF developed a basic three-step model to evaluate whether an investment is other-than-temporarily impaired. The provisions of EITF 03-1 are applied and will be applied prospectively by BMC to all current and future investments. The adoption of EITF 03-1 did not have a material effect on BMC’s results of operations and financial condition.

Liquidity and Capital Resources

     One of our key goals is to maintain and improve our capital structure. The key metrics we focus on in analyzing the strength of our balance sheet are summarized in the table below (in millions):

	Three Months Ended June 30,
	2003		2004
Cash provided by operating activities	$	124.0	$	90.1
Cash, cash equivalents, and marketable securities*	$	1,059.4	$	1,236.4
Working capital	$	236.9	$	486.9
Treasury stock acquired	$	60.0	$	20.0
Cash paid for technology acquisitions and other investments, net of cash acquired	$	6.1	$	4.8

* Includes both short and long term marketable securities

Operating Activities

     The table below aggregates certain line items from the cash flow statement to present the key items affecting cash from operating activities (in millions):

	Three Months Ended June 30,
	2003			2004
Net income (loss) after non-cash adjustments	$	53.0		$	62.6
(Increase) decrease in finance receivables		91.3			65.9
Increase (decrease) in payables to third-party financing institutions for finance receivables		(35.1	)		(18.3	)
All other, net		14.8			(20.1	)
Net cash provided by operating activities	$	124.0		$	90.1

• In the first quarter of fiscal 2005, the increase in net income (loss) after non-cash adjustments is primarily due to an increase in net earnings for the period ended June 30, 2004 over the net loss reported in the prior year quarter.

• 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 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, its source (domestic vs. international), the cost of financing and our internal cost of capital.

Investing Activities

     The table below aggregates certain line items from the cash flow statement to present the key items affecting investing activities (in millions):

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	Three Months Ended June 30,
	2003			2004
Maturities of/proceeds from sales of marketable securities	$	49.1		$	146.4
Purchases of property and equipment		(12.7	)		(16.8	)
Purchases of marketable securities		(163.2	)		(5.1	)
All other, net		(13.9	)		(19.0	)
Net cash used in investing activities	$	(140.7	)	$	105.5

• The main source of cash for investing activities is the maturities of/proceeds from sales of marketable securities, which were converted into cash equivalents.

• Included in the cash paid for technology acquisitions and other investments, net of cash acquired, is approximately $1.1 million representing acquisition costs related to our purchase of Marimba, which closed on July 15, 2004. The purchase price was approximately $255 million, including direct costs of the transaction, or approximately $225 million, net of cash acquired.

• The main component of other cash used in investing activities is capitalization of software development costs.

Financing Activities

     The table below aggregates certain line items from the cash flow statement to present the key items affecting our financing activities (in millions):

	Three Months Ended June 30,
	2003			2004
Treasury stock acquired	$	(60.0	)	$	(20.0	)
Payments on capital leases		—			(1.0	)
Stock options exercised		1.3			4.9
Net cash used in financing activities	$	(58.7	)	$	(16.1	)

• There were no borrowings during the first quarter of fiscal 2005, and the main use of cash in financing activities was the acquisition of treasury stock. During the quarter, approximately 1.2 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.

     The full Condensed Consolidated Statements of Cash Flows is included in the Condensed Consolidated Financial Statements.

Cash, Cash Equivalents and Marketable Securities

     At June 30, 2004, our cash, cash equivalents and marketable securities were $1,236.4 million, an increase of $23.4 million from the March 31, 2004 balance. This increase is primarily due to positive operating cash flow and maturities of/proceeds from sales of marketable securities, which was partially offset by purchases of equipment and treasury stock. Approximately 83% of the $1,236.4 million of cash, cash equivalents and marketable securities at June 30, 2004 is held in international locations and was largely generated from our international operations. Our international operations have generated approximately $789.0 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 $256.0 million; however, we have not provided a deferred tax liability on any portion of the $789.0 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, the IT Masters purchase price and the assets of Magic.

     Our marketable securities are primarily investment grade and highly liquid. Because of current economic trends, we have begun investing in securities with shorter original maturities.

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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 of our Annual Report on Form 10-K. During the quarter ended June 30, 2003 and 2004, we transferred $76.0 million and $43.2 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 may lead to more customer transactions where cash payments will be received over time. This flexibility will reduce our ability to transfer finance receivables in the future and will reduce our cash flow from operations in the near term.

Treasury Stock Purchased

     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 ended June 30, 2004, we purchased approximately 1.2 million shares for $20.0 million. From the inception of the repurchase plan through June 30, 2004, we have purchased 40.5 million shares for $712.6 million. The repurchase program is funded solely with domestic cash and investments, and, therefore, affects the overall domestic versus foreign 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 and sound business principles warrant their use. Our principal use of off-balance sheet arrangements has occurred historically 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 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 the use of off-balance sheet arrangements by us to return to levels experienced before we began to offer more flexible license terms to our customers.

Acquisitions

     On July 15, 2004, we acquired Marimba, Inc. for approximately $255 million, including direct costs of the transaction, or approximately $225 million, net of cash acquired. This acquisition will strengthen our BSM-related offerings through the addition of discovery and asset, change and configuration management capabilities. We funded the net 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.

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     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.

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     Maintenance revenues have increased in each of the last three fiscal years as a result of 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 as 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 reduced maintenance percentages for long-term contracts and the recent decline in our license revenues, have led to lower growth rates for our maintenance revenue, excluding the impact of Remedy revenues subsequent to the acquisition date. Further declines in our license revenue 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 revenue.

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 levels 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.

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     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. These risks are increased as we implement our BSM strategy because as part of this strategy, 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

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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.

Changes in pricing practices could adversely affect revenues and earnings.

     We may choose to make changes to our product packaging, pricing or licensing programs in response to competition or customer demands or as a means to differentiate our product offerings. If made, such changes may have a material adverse impact on revenues or earnings.

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

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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

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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 Israel, France and India, as well as the US, and continue to expand our international sales activities as part of our business strategy. As a result, we face increasing risks from our international operations, including, among others:

• difficulties in staffing and managing foreign operations;

• risk of actions that are inconsistent with acceptable business practices;

• 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 foreign 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

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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 have used 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 1(k) to the accompanying 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 $25.5 million and $16.0 million for the quarters ended June 30, 2003 and 2004, respectively. In addition, new regulations adopted by The New York Stock Exchange requiring stockholder approval for all stock option plans as well as new regulations prohibiting NYSE member organizations from giving a proxy to vote on equity-compensation plans unless the beneficial owner of the shares has given voting instructions could make it more difficult for us to grant options to employees in the future. To the extent that new regulations make it 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.

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ITEM 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

     As of June 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.

     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 control over financial reporting. However as previously disclosed in our Annual Report on Form 10-K for the year ended March 31, 2004 (the “10K”), management, in consultation with Ernst & Young LLP (E&Y), 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 10-K, the following steps have been taken by the Company as of August 9, 2004:

• a new Vice President-Controller was hired;

• a newly created position, Director of Business Controls, was filled;

• a newly created position, Director of Corporate Accounting, was filled;

• two accounting managers were hired in the U.S. region;

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

• training for accounting personnel has occurred and is ongoing; and

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

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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.

     On July 31, 2001, Nastel Technologies, Inc. (Nastel) filed a complaint in arbitration alleging breach of a licensing agreement by us, copyright infringement, and theft of trade secrets. We filed a counterclaim again Nastel for reimbursement of overpaid royalties based upon conflicting licensing agreements. We believe we have meritorious defenses for the claims asserted against us; however, an adverse financial judgment against us could have a material adverse impact on our financial results for the period in which such judgment is rendered and on our cash flow in the period in which such judgment is paid. The parties have completed the arbitration hearing and have submitted post-hearing briefing to the arbitration panel. A ruling in this matter is expected in the second fiscal quarter of 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.

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ITEM 6. Exhibits and Reports on Form 8-K

     (a) Exhibits.

10.10	BMC Software, Inc. Short-Term Incentive Performance Award Program (as amended and restated).
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 April 29, 2004, BMC Software filed a Current Report on Form 8-K, dated April 29, 2004, furnishing under Item 12 its news release to report its historical financial results for the quarter and year ended March 31, 2004.

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SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	BMC SOFTWARE, INC.
	By:	/s/ Robert E. Beauchamp
		Robert E. Beauchamp
August 9, 2004		President and Chief Executive Officer

	By:	/s/ George W. Harrington
		George W. Harrington
August 9, 2004		Senior Vice President and Chief Financial Officer

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INDEX TO EXHIBITS

Exhibit No	Description
10.10	BMC Software, Inc. Short-Term Incentive Performance Award Program (as amended and restated).
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.

EX-10.10

Exhibit 10.10

BMC SOFTWARE, INC.
SHORT-TERM INCENTIVE PERFORMANCE AWARD PROGRAM

[As Amended and Restated Effective as of April 1, 2004]

I. RESTATEMENT AND PURPOSE OF PROGRAM

     1.1 Restatement of Program. The Compensation Committee of the Board of Directors of BMC Software, Inc., a Delaware corporation (the “Company”), has heretofore adopted the BMC Software, Inc. Short-Term Incentive Performance Award Program (the “Program”). This instrument constitutes an amendment and restatement of the Program in its entirety with no interruption in time, effective as of April 1, 2004.

     1.2 Purpose of Program. The Program has been adopted by the Compensation Committee of the Company’s Board of Directors to implement in part the Performance Award provisions of the BMC Software, Inc. 2002 Employee Incentive Plan (as amended from time to time, the “Employee Incentive Plan”). The Program is intended to provide a method for attracting, motivating, and retaining key employees to assist in the development and growth of the Company and its Affiliates. The Program and Awards hereunder shall be subject to the terms of the Employee Incentive Plan, including the limitations on the maximum value of Awards contained therein.

II. DEFINITIONS AND CONSTRUCTION

     2.1 Definitions. Where the following words and phrases are used in the Program or the Program Schedule, they shall have the respective meanings set forth below, unless the context clearly indicates to the contrary:

     (a) “Affiliate” means any corporation, partnership, limited liability company or partnership, association, trust or other organization which, directly or indirectly, controls, is controlled by, or is under common control with, the Company.

     (b) “Award” means, with respect to each Participant for a Performance Period, such Participant’s opportunity to earn a Payment Amount for such Performance Period upon the satisfaction of the terms and conditions of the Program.

     (c) “Award Notice” means a written notice issued by the Company to a Participant evidencing such Participant’s receipt of an Award with respect to a Performance Period.

     (d) “Base Amount” means, with respect to each Participant and each Performance Period, the annual base rate of pay paid or payable in cash by the Company and the Affiliates to or for the benefit of the Participant for services rendered or labor performed as in effect on the earlier of (i) the date of the Participant’s termination of employment with the Company if a Change in Control occurs during such Performance Period and the Participant’s employment with the Company terminates on or after the date of such Change in Control and during such Performance Period, (ii) the date of the Participant’s termination of employment with the Company if such termination is by reason of death, Disability or Retirement, or (iii) the last day of such Performance Period; provided, however, that if “Base Amount” is to be determined

pursuant to clause (i) of this sentence, then in no event shall such amount be less than the Participant’s annual base rate of pay paid or payable in cash by the Company and the Affiliates to or for the benefit of the Participant for services rendered or labor performed as in effect on the day immediately preceding the date of the Change in Control. Base Amount shall be determined without reduction for amounts a Participant could have received in cash in lieu of (A) elective deferrals under the Company’s 1994 Deferred Compensation Plan or (B) elective contributions made on such Participant’s behalf by the Company or an Affiliate pursuant to a qualified cash or deferred arrangement (as defined in section 401(k) of the Code) or pursuant to a plan maintained under section 125 of the Code.

     (e) “Base Amount Multiplier” means, with respect to each Participant and each Performance Period, a percentage assigned to such Participant by the Committee for such Performance Period.

     (f) “Board” means the Board of Directors of the Company.

     (g) “Change in Control” means (i) the acquisition by any person or entity (including a “group” as contemplated by Section 13(d)(3) of the Securities Exchange Act of 1934, as amended) of at least 50% of the Company’s outstanding voting stock, (ii) an unapproved change in the majority of the Board, (iii) a merger, consolidation, or similar corporate transaction in which the Company’s shareholders immediately prior to the transaction do not own more than 60% of the voting stock of the surviving corporation in the transaction, or (iv) shareholder approval of the Company’s liquidation, dissolution, or sale of substantially all of its assets.

     (h) “Code” means the Internal Revenue Code of 1986, as amended.

     (i) “Committee” means a committee of the Board comprised solely of two or more outside directors (within the meaning of the term “outside directors” as used in section 162(m) of the Code and applicable interpretative authority thereunder and within the meaning of the term “Non-Employee Director” as defined in Rule 16b-3). Such committee shall be the Compensation Committee of the Board unless and until the Board designates another committee of the Board to serve as the Committee.

     (j) “Company” means BMC Software, Inc., a Delaware corporation.

     (k) “Disability” or “Disabled” means, with respect to a Participant, such Participant’s disability entitling him or her to benefits under the Company’s group long-term disability plan.

     (l) “Effective Date” means April 1, 2004, as to this amendment and restatement of the Program. The original effective date of the Program was April 1, 2003.

     (m) “Eligible Employee” means any individual who is an employee of the Company or an Affiliate.

     (n) “Employee Incentive Plan” means the BMC Software, Inc. 2002 Employee Incentive Plan, as amended from time to time.

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     (o) “Participant” means an Eligible Employee who has received an Award under the Program with respect to a Performance Period pursuant to Section 4.1.

     (p) “Participation Fraction” means, with respect to each Participant and each Performance Period:

(i)

if the Participant has been continuously employed by the Company from the first day of such Participant’s commencement of participation in the Program for such Performance Period through the last day of such Performance Period, a fraction, the numerator of which is the number of days in the period beginning on the first day of such Participant’s commencement of participation in the Program for such Performance Period and ending on the last day of such Performance Period (but excluding any days in such period during which the Participant is on a voluntary personal leave of absence), and the denominator of which is the number of days in such Performance Period; and

(ii)

if (A) the Participant’s employment with the Company terminates during such Performance Period by reason of death, Disability or Retirement or (B) a Change in Control occurs during such Performance Period and the Participant’s employment with the Company terminates on or after the date of such Change in Control and during such Performance Period for any reason whatsoever, a fraction, the numerator of which is the number of days in the period beginning on the first day of such Participant’s commencement of participation in the Program for such Performance Period and ending on the date of such Participant’s termination of employment (but excluding any days in such period during which the Participant is on a voluntary personal leave of absence), and the denominator of which is the number of days in such Performance Period.

     (q) “Payment Amount” means, with respect to each Participant and each Award for a Performance Period, an amount that the Participant will be paid under the Program if the Performance Goals with respect to such Award are satisfied; provided, however, that a Participant’s Payment Amount for an Award shall be subject to reduction as provided in Section 6.1 and may not exceed the amount specified in Section 6.5. A Participant’s Payment Amount with respect to a particular Award for a Performance Period shall be determined as provided in the Program Schedule for such Performance Period.

     (r) “Performance Goal” means, with respect to each Participant and each Award, a goal that must be achieved by the Company and/or its Affiliates in order for the Participant to receive a Payment Amount with respect to such Award. Performance Goals shall be established by the Committee and shall be based on one or more of the performance measures specified in Paragraph VIII(b) of the Employee Incentive Plan.

     (s) “Performance Period” means a period of time established by the Committee over which a Performance Goal shall be measured.

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     (t) “Program” means this BMC Software, Inc. Short-Term Incentive Performance Award Program, as amended from time to time.

     (u) “Program Schedule” means a schedule that constitutes a part of the Program and details certain particulars with respect to the Program and Awards hereunder for one or more Performance Periods. Each Program Schedule shall be adopted by the Committee or shall be prepared by the appropriate officers of the Company based on resolutions, minutes or consents adopted by the Committee. There may be more than one Program Schedule under the Program. Each Program Schedule is incorporated herein by reference and thereby made a part of the Program, and references herein to the Program shall include the Program Schedules.

     (v) “Retirement” means a Participant’s termination of employment with the Company for any reason whatsoever after attaining the age of 65.

     2.2 Number, Gender, Headings, and Periods of Time. Wherever appropriate herein, words used in the singular shall be considered to include the plural, and words used in the plural shall be considered to include the singular. The masculine gender, where appearing in the Program, shall be deemed to include the feminine gender. The headings of Articles, Sections, and Paragraphs herein are included solely for convenience. If there is any conflict between such headings and the text of the Program, the text shall control. All references to Articles, Sections, and Paragraphs are to this Program unless otherwise indicated. Any reference in the Program to a period or number of days, weeks, months, or years shall mean, respectively, calendar days, calendar weeks, calendar months, or calendar years unless expressly provided otherwise.

III. ADMINISTRATION

     3.1 Administration by the Committee. The Program shall be administered by the Committee.

     3.2 Powers of the Committee. The Committee shall supervise the administration and enforcement of the Program according to the terms and provisions hereof and shall have the sole discretionary authority and all of the powers necessary to accomplish these purposes. The Committee shall have all of the powers specified for it under the Program, including, without limitation, the power, right, or authority: (a) to designate an Eligible Employee as a Participant with respect to a Performance Period in accordance with Section 4.1, (b) from time to time to establish rules and procedures for the administration of the Program, which are not inconsistent with the provisions of the Program or the Employee Incentive Plan, and any such rules and procedures shall be effective as if included in the Program, (c) to construe in its discretion all terms, provisions, conditions, and limitations of the Program and any Award, (d) to correct any defect or to supply any omission or to reconcile any inconsistency that may appear in the Program in such manner and to such extent as the Committee shall deem appropriate, and (e) to make all other determinations necessary or advisable for the administration of the Program. The Committee may correct any defect or supply any omission or reconcile any inconsistency in the Program or in any Award or Award Notice in the manner and to the extent it shall deem expedient to carry it into effect.

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     3.3 Committee Decisions Conclusive; Standard of Care. The Committee shall, in its sole discretion exercised in good faith (which, for purposes of this Section 3.3, shall mean the application of reasonable business judgment), make all decisions and determinations and take all actions necessary in connection with the administration of the Program. All such decisions, determinations, and actions by the Committee shall be final, binding, and conclusive upon all persons. The Committee shall not be liable for any action or determination taken or made in good faith or upon reliance in good faith on the records of the Company or information presented to the Committee by the Company’s officers, employees, or other persons (including the Company’s outside auditors) as to matters the Committee reasonably believes are within such other person’s professional or expert competence. If a Participant disagrees with any decision, determination, or action made or taken by the Committee, then the dispute will be limited to whether the Committee has satisfied its duty to make such decision or determination or take such action in good faith. No liability whatsoever shall attach to or be incurred by any past, present or future stockholders, officers or directors, as such, of the Company or any of its Affiliates, under or by reason of the Program or the administration thereof, and each Participant, in consideration of receiving benefits and participating hereunder, expressly waives and releases any and all claims relating to any such liability.

IV. PARTICIPATION AND AWARD NOTICES

     4.1 Participation. The Committee shall, from time to time, in its sole discretion designate the Eligible Employees who shall become Participants in the Program with respect to a Performance Period; provided, however, that an Eligible Employee may not be selected for participation in the Program with respect to a particular Performance Period after the last day of such Performance Period. An Award to a Participant shall designate the type of such Award and the Performance Period or Performance Periods to which such Award relates. The Committee shall designate the Base Amount Multiplier that shall apply to each Participant with respect to his participation in the Program. In addition, if the effective date of a Participant’s participation in the Program with respect to a Performance Period for which such Participant receives an Award is after the first day of such Performance Period, then the Committee shall designate the effective date of such Participant’s participation in the Program with respect to such Performance Period.

     4.2 Award Notices. The Company shall provide an Award Notice to each Eligible Employee who becomes a Participant under the Program as soon as administratively feasible after such Eligible Employee becomes a Participant. An Award Notice may specify one or more Performance Periods and/or types of Awards with respect to which the Participant may participate in the Program. Further, an Award Notice may provide that the Participant shall continue to participate in the Program for successive Performance Periods until notified otherwise by the Committee or, if earlier, the date upon which he terminates employment with the Company. An Award Notice shall specify the Participant’s Base Amount Multiplier, which may be changed on a prospective basis by the Committee upon written notice to the Participant at any time prior to the commencement of a Performance Period.

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V. PERFORMANCE GOALS

     5.1 Establishment of Performance Goals. The Committee shall, in its sole discretion, establish the Performance Goal or Goals that shall apply with respect to each Award for a Performance Period. The Performance Goals with respect to an Award shall be established by the Committee not later than 90 days after the commencement of the period of service to which the Performance Goals relate; provided, however, that if the Performance Goals for an Award with respect to a Performance Period are established on or after the first day of such Performance Period, then (a) the outcome with respect to the satisfaction of such Performance Goals must be substantially uncertain at the time such Performance Goals are so established and (b) in no event may such Performance Goals be established after 25% of the period of service has elapsed. Further, if the Committee has established Performance Goals with respect to a particular Award, then the Committee may, in its sole discretion, revise any of such Performance Goals so long as such revision is made on or before the last date upon which the Committee could have originally established such Performance Goals as described in the preceding sentence. Subject to the foregoing, the Performance Goals established by the Committee for an Award with respect to a Performance Period may include alternative targets that are contingent on the occurrence or non-occurrence of a specified event. For example, the Performance Goals for an Award may include (i) one set of targets that will apply if an acquisition, divestiture or other specified corporate event occurs during the related Performance Period and (ii) a separate set of targets that will apply if such acquisition, divestiture or other specified corporate event does not occur during such Performance Period.

     5.2 Subdivision or Consolidation of Shares; Stock Dividends. If, prior to the last day of a Performance Period, the Company shall effect a subdivision or consolidation of shares of its common stock or the payment of a stock dividend on its common stock without receipt of consideration by the Company, then any Performance Goal for an Award with respect to such Performance Period that is based on or measured by a per share of common stock criteria shall be proportionately adjusted by the Committee in a manner that reflects such event; provided, however, that no such adjustment shall be made if the Performance Goals established by the Committee for such Performance Period reflect that the Committee considered such event in establishing such targets.

VI. AWARD PAYMENTS

     6.1 Determinations and Certification by the Committee. As soon as administratively feasible after the end of each Performance Period, the Committee shall determine whether the Performance Goals applicable to Awards for such Performance Period were satisfied and, if such Performance Goals were satisfied in whole or in part, the Payment Amount, if any, for each Participant holding such an Award. Notwithstanding any provision herein to the contrary, at any time prior to the date an amount is paid to or for the benefit of a Participant pursuant to Section 6.2 with respect to a Performance Period, the Committee may, in its sole discretion, reduce the Payment Amount that would otherwise be payable pursuant to Section 6.2 (but not Section 6.3) to such Participant for such Performance Period based on the Committee’s view of such Participant’s performance and/or the Company’s performance during such Performance Period. Any such reduction may be made with respect to one or more Participants and not other Participants, and the magnitude of such reductions may vary among

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individual Participants. The Committee’s determinations pursuant to the preceding provisions of this Section 6.1 for each Performance Period and any other material terms relating to the payment of an Award shall be certified by the Committee in writing and delivered to the Secretary of the Company no later than six weeks after the last day of such Performance Period. For purposes of the preceding sentence, approved minutes of the Committee meeting in which the certification is made shall be treated as a written certification.

     6.2 Eligibility for Payment of Awards. Upon the Committee’s written certification in accordance with Section 6.1 that a Payment Amount for an Award with respect to a Performance Period is due under the Program, each Participant who has received an Award with respect to such Performance Period and who has remained continuously employed by the Company or an Affiliate (or was on a voluntary personal leave of absence approved by the Company) from the effective date as of which such Participant received such Award until the last day of such Performance Period shall be entitled to the Payment Amount applicable to such Participant’s Award for such Performance Period. Further, if a Participant received an Award with respect to such Performance Period and his employment with the Company terminated during such Performance Period by reason of death, Disability or Retirement, then such Participant shall be entitled to the Payment Amount applicable to such Participant’s Award for such Performance Period. Except as provided in the preceding sentence or in Section 6.3, if a Participant’s employment with the Company terminates for any reason whatsoever prior to the last day of a Performance Period, then such Participant shall not be entitled to receive any payment under the Program with respect to his or her Award for such Performance Period. Without limiting the scope of the preceding sentence, if a Participant’s employment with the Company terminates during a Performance Period by reason of death, Disability or Retirement, then such Participant shall not be entitled to any payment under the Program with respect to any Performance Period that begins after the date of such termination of employment. Payment of the amount to which a Participant becomes entitled pursuant to this Section 6.2 shall be made by the Company as soon as administratively feasible after the Committee’s written certification that a Payment Amount is due under the Program.

     6.3 Change in Control. Upon the occurrence of a Change in Control, the provisions of Sections 6.1 and 6.2 shall cease to apply with respect to Awards for the Performance Period during which such Change in Control occurs and the Company shall be required to pay a Payment Amount (as determined below) for such Awards to each Participant who is employed by the Company on the day immediately prior to the Change in Control (or who is on a voluntary personal leave of absence at such time that has been approved by the Company or who has terminated employment with the Company during such Performance Period and prior to such Change in Control by reason of death, Disability or Retirement). For purposes of this Section 6.3, the Payment Amount for each Participant who is entitled to a payment pursuant to this Section 6.3 shall be calculated as if the Performance Goal or Goals applicable to an affected Award were achieved at a level specified in the Program Schedule for purposes of this Section 6.3. The Payment Amount determined under this Section 6.3 shall be paid to each eligible Participant as soon as administratively feasible after the last day of the Performance Period in which the Change in Control occurs; provided, however, that (a) with respect to a Participant whose employment with the Company terminated during such Performance Period and prior to the Change in Control by reason of death, Disability or Retirement, then such payment shall be paid to such Participant as soon as administratively feasible after the date of the Change in

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Control, and (b) with respect to a Participant whose employment with the Company terminated during such Performance Period and on or after the date of the Change in Control for any reason whatsoever, then such payment shall be paid to such Participant as soon as administratively feasible after the date of his termination of employment.

     6.4 Form of Payment of Awards. All payments to be made under the Program to a Participant with respect to an Award for a Performance Period shall be paid in a single lump sum cash payment.

     6.5 Maximum Payment Amount. In no event shall the Payment Amount for an Award for any particular Performance Period that is paid to or on behalf of any one individual under this Program exceed $1,000,000; provided, however, that all Payment Amounts for Awards hereunder shall be subject to the limitations set forth in Paragraph V(a) of the Employee Incentive Plan.

VII. TERMINATION AND AMENDMENT OF PROGRAM

     The Committee may amend the Program at any time and from time to time; provided, however, that the Program may not be amended after the last day of a Performance Period in a manner that would impair the rights of any Participant with respect to any outstanding Award pertaining to such Performance Period without the consent of such Participant. The Committee may at any time prior to the last day of a Performance Period terminate the Program (in its entirety or as it applies to one or more specified Affiliates) with respect to such Performance Period and subsequent Performance Periods. Notwithstanding the foregoing, the Program may not be amended or terminated in contemplation of or in connection with a Change in Control, nor may any Participant’s participation herein be terminated in contemplation of or in connection with a Change in Control, unless adequate and effective provision for the making of all payments otherwise payable pursuant to Section 6.3 of the Program with respect to such Change in Control shall be made in connection with any such amendment or termination. The Committee shall remain in existence after the termination of the Program for the period determined necessary by the Committee to facilitate the termination of the Program, and all provisions of the Program that are necessary, in the opinion of the Committee, for equitable operation of the Program during such period shall remain in force.

VIII. MISCELLANEOUS PROVISIONS

     8.1 No Effect on Employment Relationship. For all purposes of the Program, a Participant shall be considered to be in the employment of the Company as long as he remains employed on a full-time basis by the Company or any Affiliate. Without limiting the scope of the preceding sentence, it is expressly provided that a Participant shall be considered to have terminated employment with the Company at the time of the termination of the “Affiliate” status under the Program of the entity or other organization that employs the Participant. Nothing in the adoption of the Program, the grant of Awards, or the payment of amounts under the Program shall confer on any person the right to continued employment by the Company or any Affiliate or affect in any way the right of the Company (or an Affiliate, if applicable) to terminate such employment at any time. Unless otherwise provided in a written employment agreement, the employment of each Participant shall be on an at-will basis, and the employment relationship

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may be terminated at any time by either the Participant or the Participant’s employer for any reason whatsoever, with or without cause. Any question as to whether and when there has been a termination of a Participant’s employment for purposes of the Program, and the reason for such termination, shall be determined solely by and in the discretion of the Committee, and its determination shall be final, binding, and conclusive on all parties.

     8.2 Prohibition Against Assignment or Encumbrance. No Award or other right, title, interest, or benefit hereunder shall ever be assignable or transferable, or liable for, or charged with any of the torts or obligations of a Participant or any person claiming under a Participant, or be subject to seizure by any creditor of a Participant or any person claiming under a Participant. No Participant or any person claiming under a Participant shall have the power to anticipate or dispose of any Award or other right, title, interest, or benefit hereunder in any manner until the same shall have actually been distributed free and clear of the terms of the Program. Payments with respect to an Award shall be payable only to the Participant (or (a) in the event of a Disability that renders such Participant incapable of conducting his or her own affairs, any payment due under the Program to such Participant shall be made to his or her duly appointed legal representative and (b) in the event of the death of a Participant, any payment due under the Program to such Participant shall be made to his or her estate). The provisions of the Program shall be binding on all successors and permitted assigns of a Participant, including without limitation the estate of such Participant and the executor, administrator or trustee of such estate, or any receiver or trustee in bankruptcy or representative of the Participant’s creditors.

     8.3 Unfunded, Unsecured Program. The Program shall constitute an unfunded, unsecured obligation of the Company to make payments of incentive compensation to certain individuals from its general assets in accordance with the Program. Each Award granted under the Program merely constitutes a mechanism for measuring such incentive compensation and does not constitute a property right or interest in the Company, any Affiliate, or any of their assets. Neither the establishment of the Program, the granting of Awards, nor any other action taken in connection with the Program shall be deemed to create an escrow or trust fund of any kind.

     8.4 No Rights of Participant. No Participant shall have any security or other interest in any assets of the Company or any Affiliate or in the securities issued by the Company or any Affiliate as a result of participation in the Program. Participants and all persons claiming under Participants shall rely solely on the unsecured promise of the Company set forth herein, and nothing in the Program, an Award or an Award Notice shall be construed to give a Participant or anyone claiming under a Participant any right, title, interest, or claim in or to any specific asset, fund, entity, reserve, account, or property of any kind whatsoever owned by the Company or any Affiliate or in which the Company or any Affiliate may have an interest now or in the future; but each Participant shall have the right to enforce any claim hereunder in the same manner as a general creditor. Neither the establishment of the Program nor participation hereunder shall create any right in any Participant to make any decision, or provide input with respect to any decision, relating to the business of the Company or any Affiliate.

     8.5 Tax Withholding. The Company and the Affiliates shall deduct and withhold, or cause to be withheld, from a Participant’s payment made under the Program, or from any other payment to such Participant, an amount necessary to satisfy any and all tax withholding

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obligations arising under applicable local, state, federal, or foreign laws associated with such payment. The Company and the Affiliates may take any other action as may in their opinion be necessary to satisfy all obligations for the payment and withholding of such taxes.

     8.6 No Effect on Other Compensation Arrangements. Nothing contained in the Program or any Participant’s Award or Award Notice shall prevent the Company or any Affiliate from adopting or continuing in effect other or additional compensation arrangements affecting any Participant. Nothing in the Program shall be construed to affect the provisions of any other compensation plan or program maintained by the Company or any Affiliate.

     8.7 Affiliates. The Company may require any Affiliate employing a Participant to assume and guarantee the Company’s obligations hereunder to such Participant, either at all times or solely in the event that such Affiliate ceases to be an Affiliate.

     8.8 Governing Law. The Program shall be construed in accordance with the laws of the State of Texas.

     IN WITNESS WHEREOF, the undersigned officer of the Company acting pursuant to authority granted to him by the Committee has executed this instrument as of the 20th day of July, 2004, effective as of the Effective Date.

BMC SOFTWARE, INC.
By:	/s/ Jerome Adams
Name:	Jerome Adams
Title:	Senior Vice President, Administration

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PROGRAM SCHEDULE
UNDER THE BMC SOFTWARE, INC.
SHORT-TERM INCENTIVE PERFORMANCE AWARD PROGRAM
FOR PERFORMANCE PERIODS DURING THE FISCAL YEAR
BEGINNING ON APRIL 1, 2004

Capitalized terms that are not defined in this Program Schedule shall have the meanings assigned to such terms in the BMC Software, Inc. Short-Term Incentive Performance Award Program, as amended and restated effective as of April 1, 2004. This Program Schedule applies to all Performance Periods during the Company’s fiscal year beginning on April 1, 2004.

1. EPS Awards

EPS Performance Period – Each three-month period beginning on April 1, 2004, July 1, 2004, October 1, 2004, and January 1, 2005. An EPS Performance Period constitutes a Performance Period under the Program.

EPS - - With respect to an EPS Performance Period, the non-GAAP earnings per share of common stock of the Company for such EPS Performance Period as reported by the Company in its quarterly earnings press release which equals reported earnings per share of common stock of the Company for such EPS Performance Period, calculated in accordance with generally accepted accounting principles (“GAAP”), but adjusted as follows:

(i)	Exclude acquisition related expenses for acquired research and development;
(ii)	Exclude amortization of acquired technology and intangibles;
(iii)	For the EPS Performance Period that begins on April 1, 2004 (but not for any subsequent EPS Performance Period), exclude the earnings or losses generated with respect to assets or businesses acquired during such EPS Performance Period from the date of close of such acquisition to the last day of such Performance Period;
(iv)	For the EPS Performance Period that begins on April 1, 2004 (but not for any subsequent EPS Performance Period), add or subtract the earnings or losses that would have been generated with respect to assets or businesses divested during such EPS Performance Period from the date of close of such divestiture to the last day of the EPS Performance Period (the amount of such earnings and losses for such period shall be based on budgeted revenues and expenses established as of the first day of such EPS Performance Period); and
(v)	Exclude or add the effect of any non-recurring extraordinary items;

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provided, that no such adjustment shall be made to earnings per share calculated in accordance with GAAP to the extent that the EPS targets established by the Committee for such EPS Performance Period reflect that the Committee considered the adjustment, or event leading to the adjustment, in establishing such targets. In addition, EPS for an EPS Performance Period shall be calculated without regard to any change in GAAP accounting standards that takes effect during such EPS Performance Period unless the EPS targets established by the Committee for such EPS Performance Period reflect that the Committee considered such change in establishing such targets. EPS for each EPS Performance Period shall be rounded to the nearest penny. The EPS targets for each EPS Performance Period were initially established by the Committee in accordance with Section 5.1 of the Program at a meeting of the Committee held on April 19, 2004, and such EPS targets are reflected in the minutes to such meeting. EPS constitutes a Performance Goal under the Program.

EPS Award - With respect to each Participant for an EPS Performance Period, such Participant’s opportunity to earn an EPS Payment Amount for such EPS Performance Period upon the satisfaction of the terms and conditions of the Program. EPS Awards shall constitute Awards under the Program and Performance Awards (as such term is defined in the Employee Incentive Plan) under the Employee Incentive Plan that are based on the Company’s earnings per share (as more fully described in this Program Schedule).

EPS Payment Amount - With respect to each Participant and each EPS Award for an EPS Performance Period for which at least the minimum EPS target has been achieved by the Company, an amount equal to A multiplied by B multiplied by C multiplied by D multiplied by E, where:

A	equals the incentive compensation attainment percentage determined for such EPS Performance Period from the schedules approved by the Committee at its meeting on April 19, 2004, based on the actual EPS achieved by the Company for such EPS Performance Period;
B	equals such Participant’s Base Amount for such EPS Performance Period;
C	equals such Participant’s Base Amount Multiplier for such EPS Performance Period;
D	equals 17.5%; and
E	equals such Participant’s Participation Fraction for such EPS Performance Period.

An EPS Payment Amount constitutes a Payment Amount under the Program.

2. Net Bookings Awards

Net Bookings Performance Period – The 12-month period beginning on April 1, 2004. The Net Bookings Performance Period constitutes a Performance Period under the Program.

Net Bookings –With respect to the Net Bookings Performance Period, the total dollar value of all license and maintenance contracts (based on the actual contract value) received by the Company

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and its subsidiaries during the Net Bookings Performance Period, regardless of whether such contracts are booked currently or ratably. To be considered as a booking, revenue from a contract must result in a financial statement impact, either on the Company’s income statement as revenue or on the Company’s balance sheet as deferred revenue. The Net Bookings targets for the Net Bookings Performance Period were initially established by the Committee in accordance with Section 5.1 of the Program at a meeting of the Committee held on April 19, 2004, and such Net Bookings targets are reflected in the minutes to such meeting. Net Bookings constitutes a Performance Goal under the Program.

Net Bookings Award – With respect to each Participant for the Net Bookings Performance Period, such Participant’s opportunity to earn a Net Bookings Payment Amount for the Net Bookings Performance Period upon the satisfaction of the terms and conditions of the Program. Net Bookings Awards shall constitute Awards under the Program and Performance Awards (as such term is defined in the Employee Incentive Plan) under the Employee Incentive Plan that are based on the Company’s sales (as more fully described in this Program Schedule).

Net Bookings Payment Amount – If at least the minimum Net Bookings target for the Net Bookings Performance Period has been achieved, then an amount determined with respect to each Participant and each Net Bookings Award in an amount equal to A multiplied by B multiplied by C multiplied by D multiplied by E, where:

A	equals the incentive compensation attainment percentage determined for the Net Bookings Performance Period from the schedule approved by the Committee at its meeting on April 19, 2004, based on the actual Net Bookings achieved by the Company for the Net Bookings Performance Period;
B	equals such Participant’s Base Amount for the Net Bookings Performance Period;
C	equals such Participant’s Base Amount Multiplier for the Net Bookings Performance Period;
D	equals 30%; and
E	equals such Participant’s Participation Fraction for the Net Bookings Performance Period.

A Net Bookings Payment Amount constitutes a Payment Amount under the Program.

3. Change in Control

For purposes of the second sentence of Section 6.3 of the Program, the EPS Payment Amount for an EPS Award with respect to an EPS Performance Period during which a Change in Control occurs shall be calculated as provided in section 1 above as if the EPS actually achieved during such EPS Performance Period was (i)    if the Change in Control occurs during the EPS Performance Period beginning on April 1, 2004, (ii)    if the Change in Control occurs during the EPS Performance Period beginning on July 1, 2004, (iii) ______ if the Change in Control occurs during the EPS Performance Period beginning on October 1, 2004, or (iv) ______ if the Change in Control occurs during the EPS Performance Period beginning on January 1, 2005.

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If a Change in Control occurs during the Net Bookings Performance Period, then, for purposes of the second sentence of Section 6.3 of the Program, the Net Bookings Payment Amount for a Net Bookings Award shall be calculated as provided in section 2 above as if the Net Bookings actually achieved for the Net Bookings Performance Period was equal to________.

     IN WITNESS WHEREOF, the undersigned officer of the Company acting pursuant to authority granted to him by the Committee has executed this instrument as of the 20th day of July, 2004, effective as of the Effective Date.

BMC SOFTWARE, INC.
By:	/s/ Jerome Adams
Name:	Jerome Adams
Title:	Senior Vice President, Administration

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EX-31.1

Exhibit 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER
OF BMC SOFTWARE, INC.

I, Robert E. Beauchamp, certify that:

1.	I have reviewed this Quarterly Report on Form 10-Q of BMC Software, Inc. (the “registrant”);
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a.	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b.	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
c.	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a.	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b.	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 9, 2004

By:	/s/ ROBERT E. BEAUCHAMP
	Robert E. Beauchamp
	Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER
OF BMC SOFTWARE, INC.

I, George W. Harrington, certify that:

1.	I have reviewed this Quarterly Report on Form 10-Q of BMC Software, Inc. (the “registrant”);
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a.	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b.	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
c.	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a.	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b.	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 9, 2004

By:	/s/ GEORGE W. HARRINGTON
	George W. Harrington
	Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION OF
CHIEF EXECUTIVE OFFICER
OF BMC SOFTWARE, INC.
PURSUANT TO 18 U.S.C. § 1350

     Based on my knowledge, I, Robert E. Beauchamp, Chief Executive Officer of BMC Software, Inc. (the “Company”), hereby certify that the accompanying report on Form 10-Q for the period ending June 30, 2004 and filed with the Securities and Exchange Commission on the date hereof pursuant to Section 13(a) of the Securities Exchange Act of 1934 (the “Report”) by the Company fully complies with the requirements of that section.

     Based on my knowledge, I further certify that the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ ROBERT E. BEAUCHAMP  

Robert E. Beauchamp 

August 9, 2004

EX-32.2

Exhibit 32.2

CERTIFICATION OF
CHIEF FINANCIAL OFFICER
OF BMC SOFTWARE, INC.
PURSUANT TO 18 U.S.C. § 1350

     Based on my knowledge, I, George W. Harrington, Chief Financial Officer of BMC Software, Inc. (the “Company”), hereby certify that the accompanying report on Form 10-Q for the period ending June 30, 2004 and filed with the Securities and Exchange Commission on the date hereof pursuant to Section 13(a) of the Securities Exchange Act of 1934 (the “Report”) by the Company fully complies with the requirements of that section.

     Based on my knowledge, I further certify that the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ GEORGE W. HARRINGTON  

George W. Harrington 

August 9, 2004