UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

Commission File Number 001-16393

BMC Software, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:

(713) 918-8800

Securities Registered Pursuant to Section 12(b) of the Act:

Securities Registered Pursuant to Section 12(g) of the Act:

None

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

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     þ

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

      The aggregate market value of the registrant’s voting stock held by non-affiliates of the registrant, based upon the last reported sale price of the registrant’s common stock on September 30, 2004 was $3,499,415,581.

      As of June 22, 2005, there were outstanding 217,252,060 shares of common stock, par value $.01, of the registrant.

Documents Incorporated by Reference

      Portions of the following documents are incorporated by reference in this report:

      Definitive Proxy Statement filed in connection with the registrant’s Annual Meeting of Stockholders currently scheduled to be held on August 23, 2005 (Part III of this Report).

      Such Proxy Statement shall be deemed to have been “filed” only to the extent portions thereof are expressly incorporated by reference.

TABLE OF CONTENTS

      This Annual Report on Form 10-K 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 Management’s Discussion and Analysis of Financial Condition and Results of Operations — Certain Risks and Uncertainties. You should also carefully review the cautionary statements described in the other documents we file from time to time with the Securities and Exchange Commission (SEC), specifically all Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. Information contained on our website is not part of this Report.

PART I

Overview

      BMC Software is one of the world’s largest independent software vendors. Delivering Business Service Management, we provide software solutions that empower companies to manage their information technology (IT) infrastructure from a business perspective. Our extensive portfolio of software solutions spans enterprise systems, applications, databases and service management. We were organized as a Texas corporation in 1980 and were reincorporated in Delaware in July 1988. Our principal corporate offices are located at 2101 CityWest Boulevard, Houston, Texas 77042-2827. Our telephone number is (713) 918-8800, and our primary internet address is http://www.bmc.com.

      We file annual, quarterly and current reports, proxy statements and other information with the SEC. These filings and all related amendments are available free of charge at our website at http://www.bmc.com/investors. We will post all of our SEC documents to our website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. Our corporate governance guidelines and charters of key Board of Directors committees are also available on our website, as is our code of business conduct and ethics. Printed copies of each of these documents are available to stockholders upon request by contacting our investor relations department at (800) 841-2031 ext. 4525 or via email at investor@bmc.com.

Strategy

      BMC Software’s strategy is to provide software solutions to IT and business organizations for managing critical applications and infrastructure. Our solutions enable our customers to reliably and cost effectively align the technologies they use with the objectives of the customers they support. Essentially, we help our customers serve their own customers better. BMC Software was the first major enterprise software provider to adopt the business service management (BSM) strategy. This strategy resonates with customers. Industry analysts say that while our competitors label their attempts to emulate our strategy business service management, BMC Software is leading the industry in delivering on this promise to our customers. We strive to keep our suite of solutions more comprehensive so that we can help our customers manage even the most diverse infrastructure configurations and more innovative so that we can help our customers stay ahead of their own competition.

      Helping our customers align their IT infrastructure and operations with the needs of their business requires a robust structure that can be adopted universally or incrementally. To accomplish this, we focus on eight solution areas that are proven paths for BSM implementation. Focusing on these eight “Routes to Value,” we work with customers, partners and systems integrators to solve critical IT and business alignment issues. The Routes to Value include Incident & Problem Management, Asset Management & Discovery, Identity Management, Service Impact & Event Management, Service Level Management, Capacity Management & Provisioning, Infrastructure & Application Management and Change & Configuration Management. Underlying these solutions is a family of enabling technologies called BMC® Atrium that provide information sharing and centralized management across our solutions and other providers’ products. One of the key components of BMC Atrium is the Configuration Management Database (CMDB), which was released in January 2005. The BMC Atrium CMDB is an open-architected, intelligent data repository that provides a working model of a customer’s IT infrastructure. Through this model, the CMDB allows customers to link together new and legacy technologies so that they can have a single view of the business impact that IT changes are causing.

      A critical element of our BSM strategy is to provide best practices for each of our key solution areas. To do this, we have increased our investment in delivering thought leadership and consultative services, including education, as part of our solution delivery approach. One of our key areas of focus is providing best practices consistent with the IT Infrastructure Library (ITIL). ITIL is the most widely adopted IT-related best practice framework that has been developing in the IT community for approximately 20 years. In response to customer requests, we are also investing in, developing and marketing solutions that address the challenges of

audit and regulatory compliance affecting the IT organization. Our BSM Routes to Value support our IT Infrastructure Library best practices and assist in addressing issues around compliance.

      BMC Software’s competitive strength is our ability to offer a broad set of innovative and integrated solutions to the market that deliver IT and business alignment. During the past year we strengthened our BSM offerings through both acquisitions and internal development. The acquisition of Marimba® strengthens our change and configuration management offerings, while the acquisitions of Calendra and OpenNetwork Technologies® strengthen our identity management offerings. During the past year we released innovative discovery technologies and integrated our BSM offerings with the introduction of the BMC Atrium CMDB. Through these acquisitions and integrations with our software, we provide our customers more complete solutions that dramatically lessen their integration and support costs. Our acquisitions are discussed in more detail under Management’s Discussion and Analysis of Financial Condition and Results of Operations — Acquisitions.

      Our BSM strategy gained momentum in the market during fiscal 2005. This is demonstrated by our strong partnerships with industry-leading companies and by the feedback we are getting from our customers in the form of completed transactions. We completed numerous BSM-related transactions in fiscal 2005 with some of the largest companies in the world. BSM is a multi-year investment for our customers and for us. Going forward we will continue to develop products and solutions that make it easier for our customers to respond to the rapid changes in their businesses. We will also continue to develop partnerships and pursue acquisition opportunities as the market evolves.

Products

      During fiscal 2005, we managed our business along the following broad product categories: Mainframe Management, Distributed Systems Management, Service Management and Identity Management. For financial information related to these product categories, see Note 10 to the accompanying Consolidated Financial Statements.

      Our Mainframe Management solutions provide intelligent automated tools that not only optimize the availability and throughput of customers’ mainframe environments, but also enable our customers to effectively exploit this technology to meet their business needs. The Mainframe Management segment includes our MAINVIEW® solutions, which manage, automate and optimize the depth and breadth of z/ OS, DB2, CICS, IMS, Linux, middleware, the Web and storage. This segment also includes our industry-leading SmartDBA® solutions that manage and recover DB2 and IMS databases. Our Mainframe Management solutions contributed approximately 45%, 38% and 34% of our license revenues in fiscal 2003, 2004 and 2005, respectively.

      Our Distributed Systems Management solutions include our PATROL® solutions that manage IT infrastructure in distributed computing environments; our SmartDBA solutions that manage Oracle, DB2 UDB, MS SQL Server and Sybase databases; our jobs scheduling and output management products; our applications management solutions that manage SAP and Siebel environments; and our Enterprise Performance Assurance® solutions that optimize system performance and capacity planning. Our Distributed Systems Management solutions contributed approximately 45%, 41% and 37% of our license revenues in fiscal 2003, 2004 and 2005, respectively.

      Our Service Management solutions enable customers to ensure IT service levels and to discover, understand, model, respond to and track IT system problems and business services failures. The Service Management segment includes Service Delivery Management, Service Impact Management, IT Service Management for the Enterprise, IT Service Support for the Small & Mid-sized Business, IT Service

Management for Outsourcers, IT Discovery and Software Configuration Management. Our Service Management solutions contributed approximately 6% of our license revenues in fiscal 2003, including only four months of revenues from our Remedy® products after that acquisition, and contributed 19% and 27% of our license revenues in fiscal 2004 and 2005, respectively, including the impact of the Magic and Marimba acquisitions during those years, respectively.

      Our Identity Management solutions manage identities and access requirements to strengthen the overall security of our customers’ IT systems and improve their ability to meet regulatory compliance requirements. The BMC Software Identity Management suite is comprised of proven, scalable, integrated products to facilitate enterprise directory management and visualization, web access control, user administration and provisioning, password management and audit and compliance management. Our customers rely on BMC Software Identity Management solutions in some of the largest, most complex and challenging environments. This segment contributed approximately 3%, 2% and 2% of our license revenues in fiscal 2003, 2004 and 2005, respectively.

Sales and Marketing

      We market and sell our products in most major world markets directly through our sales force and indirectly through channel partners, including resellers, distributors and systems integrators. Our sales force includes an inside sales division which provides us a lower-cost channel for additional sales into existing customers and for expanding our customer base.

International Operations

      Approximately 47%, 48% and 48% of our total revenues in fiscal 2003, 2004 and 2005, respectively, were derived from business outside the United States. Revenues from our foreign subsidiaries are denominated in local currencies, as are operating expenses incurred in these locales. To date, we have not had any material foreign currency exchange gains or losses. For a discussion of our currency hedging program and the impact of currency fluctuations on international license revenues in fiscal 2004 and 2005, see Management’s Discussion and Analysis of Financial Condition and Results of Operations — Product License Revenues; Quantitative and Qualitative Disclosures about Market Risk and Note 1(g) to the accompanying Consolidated Financial Statements. We have not previously experienced any difficulties in exporting our products, but no assurances can be given that such difficulties will not occur in the future. For additional financial information regarding our domestic and international operations, see Management’s Discussion and Analysis of Financial Condition and Results of Operations — Revenues and Note 10 to the accompanying Consolidated Financial Statements.

      We are a global company conducting sales, sales support, product development and support, marketing and product distribution services from numerous international offices. In addition to our sales offices located in major economic centers around the world, we also conduct development activities in Israel, India, France and Belgium, as well as in small offices in other locations. We plan to continue to look for opportunities to efficiently expand our operations in international locations that offer highly talented resources as a way to maximize our global competitiveness. For a discussion of various unusual risks associated with our global operations and investments, see Management’s Discussion and Analysis of Financial Condition and Results of Operations — Certain Risks and Uncertainties — Risks related to global operations.

Maintenance, Enhancement and Support Services

      Revenues from providing maintenance, enhancement and support services (collectively, maintenance) comprised 48%, 53% and 56% of our total revenues in fiscal 2003, 2004 and 2005, respectively. Payment of maintenance, enhancement and support fees generally entitles a customer to telephone and Internet support and problem resolution services, including proactive notification, electronic support requests and a resolution database, and enhanced versions of products released during the maintenance period, including new versions necessary to run with the most current releases of the operating systems, databases and other software

supported by our products. Such maintenance fees are an important source of recurring revenue to us, and we invest significant resources in providing maintenance services and new product versions. Customers continue to enroll in our maintenance, enhancement and support program because they require forward compatibility and enhanced product features when they install new versions of the operating systems, databases and other software supported by our products. Our customers also value the immediate problem resolution provided, because they use our products to manage their business-critical IT systems.

Professional Services

      Our professional services group consists of a worldwide team of experienced software consultants who provide implementation, integration and education services related to our products. By easing the implementation of our products, these services help our customers accelerate the time to value. By improving the overall customer experience, these services also drive future software license transactions with these customers. Professional services contributed approximately 6% of our revenues for each of fiscal 2003, 2004 and 2005.

Product Pricing and Licensing

      Our software solutions are licensed under multiple license types using a variety of business metrics. We have historically licensed our software primarily on a perpetual basis; however, we also provide customers the right to use our software for a defined period of time, which is referred to as a term contract. Under a term contract, the customer receives the license rights to use the software, combined with the related maintenance, enhancement and support services, for the term of the contract. Some of our more common perpetual licensing models are as follows:

      For a discussion of our revenue recognition policies and the impact of our licensing models on revenue, see Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and — Product License Revenues and Note 1(i) to the accompanying Consolidated Financial Statements.

      We make extended payment terms for our products and services available for qualifying transactions. By providing such financing, we allow our customers to better manage their IT expenditures and cash flows. Our financing program is discussed in further detail below under Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.

Research and Development

      In fiscal 2003, 2004 and 2005, research and development expenses represented 16%, 18% and 15% of our total revenues, respectively. These costs relate primarily to the compensation of research and development personnel for the work they perform before products reach the point of technological feasibility. Although we develop many of our products internally, we may acquire technology through business combinations or through licensing from third parties when appropriate. Our expenditures on research and development activities in the last three fiscal years are discussed below under Management’s Discussion and Analysis of Financial Condition and Results of Operations — Research and Development.

      We conduct research and development activities in Houston and Austin, Texas, Waltham, Massachusetts, Sunnyvale, California, Israel, India, France and Belgium, as well as in small offices in other locations

around the world. Product manufacturing and distribution is based in Houston, Texas, with European manufacturing and distribution based in Dublin, Ireland.

Seasonality

      We tend to experience a higher volume of transactions and associated revenues in the quarter ending December 31, which is our third fiscal quarter, and the quarter ending March 31, which is our fourth fiscal quarter, as a result of our customers’ spending patterns and our annual sales quota incentives. As a result of this seasonality for license transactions, we tend to have greater operating cash flow in our first and fourth fiscal quarters.

Competition

      The enterprise management software business is highly competitive. Our largest competitors are IBM, Computer Associates and Hewlett Packard (HP). In addition, there are numerous independent software companies that compete with one or more of our software solutions. Although we believe we are uniquely positioned to offer BSM solutions to customers, several of our major competitors have begun to market BSM-like solutions, and we anticipate continued competition in the BSM marketplace. Although no company competes with us across our entire software solution line, we consider at least 100 firms to be directly competitive with one or more of our enterprise software solutions. Some of these companies have substantially larger operations than ours in the specific markets in which we compete. In addition, the software industry is experiencing continued consolidation.

      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. Certain of our solutions in the Mainframe Management product group compete directly with IBM, primarily with IBM’s IMS and DB2 database management systems, and its IMS/ TM and CICS transaction managers. Some of our solutions, including our core IMS and DB2 database tools and utilities, are essentially improved versions of system software utilities that are provided as part of these integrated IBM system software products. IBM also markets separately priced competing utilities in addition to its base utilities. To date, our solutions have competed well against IBM’s solutions because we have developed advanced automation and artificial intelligence features and our utilities have maintained a speed advantage. 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 and appears to be committed to competing in these markets. 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 products, our 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.

      We believe that the key criteria considered by potential purchasers of our products are as follows: operational advantages and cost savings provided; expected return on investment; product quality and capability; product price and the terms on which the product is licensed; ease of integration of the product with the purchaser’s existing systems; ease of product installation and use; and quality of support and product documentation. Because potential purchasers of our products typically acquire such software to manage critical IT systems, they often consider the market experience and financial health of the vendor in making their purchasing decision.

Customers

      No single customer accounted for a material portion of our revenues during any of the past three fiscal years. Our software products are generally used in a broad range of industries, businesses and applications. Our

customers include manufacturers, telecommunications companies, financial service providers, educational institutions, retailers, distributors, hospitals, service providers, government agencies and value-added resellers.

Intellectual Property

      We distribute our products in object code form and rely upon contract, trade secret, copyright and patent laws to protect our intellectual property. The license agreements under which customers use our products restrict the customer’s use to its own operations and prohibit disclosure to third persons. We distribute certain of our products on a shrink-wrap basis, and the enforceability of such restrictions in a shrink-wrap license is unproven in certain jurisdictions. Also, notwithstanding these restrictions, it is possible for other persons to obtain copies of our products in object code form. We believe that obtaining such copies would have limited value without access to the product’s source code, which we keep highly confidential. In addition, we employ protective measures such as CPU dependent passwords, expiring passwords and time-based trials.

Employees

      As of March 31, 2005, we had 6,905 full-time employees. Subsequent to that date, we implemented a plan to eliminate 825 to 875 employee positions as discussed below under Management’s Discussion and Analysis of Financial Condition and Results of Operations — Operating Expenses and Note 12 to the accompanying Consolidated Financial Statements. Notwithstanding our recent reduction in workforce, we believe that our continued success will depend in part on our ability to attract and retain highly skilled technical, sales, marketing and management personnel.

      Our headquarters and principal marketing and product development operations are located in Houston, Texas, where we own four office buildings totaling approximately 1,515,000 square feet, of which we occupy approximately 41%. We lease a portion of the remaining space to third parties. We also maintain development and sales organizations in various locations around the world where we lease the necessary facilities. A summary of our principal leased properties currently in use is as follows:

      In January 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 held by us and one or more of our trademarks. In August 2003, the Court ordered the case stayed pending arbitration. In September 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. In November 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. In November 2004, we were awarded an interim ruling from the arbitration

panel that eliminates several of NetIQ’s asserted defenses in this case. In April 2005, we amended our Statement of Claim to allege that one or more of NetIQ’s software products infringe a second valid U.S. patent held by us. Discovery is in the early stages, and a final hearing in the case is not expected before calendar year 2006.

      During the year ended March 31, 2005, we paid a settlement of $11.3 million in the previously disclosed case with Nastel Technologies, Inc.

      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.

      Not Applicable.

PART II

      Our common stock is listed on the New York Stock Exchange and trades under the symbol BMC. On June 22, 2005 there were 1,213 holders of record of our common stock.

      The following table sets forth the high and low intra-day sales prices per share of common stock for the periods indicated.

      We have never declared or paid dividends to BMC Software stockholders. We do not intend to pay any cash dividends in the foreseeable future. We currently intend to retain any future earnings otherwise available for cash dividends on the common stock for use in our operations, for acquisitions and for stock repurchases. See Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.

ISSUER PURCHASES OF EQUITY SECURITIES

      Information regarding our equity compensation plans as of March 31, 2005 is incorporated by reference into Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

      The following selected consolidated financial data presented under the captions Statement of Operations Data and Balance Sheet Data for, and as of the end of, each of the years in the five-year period ended March 31, 2005, are derived from the Consolidated Financial Statements of BMC Software, Inc. and its subsidiaries. The following business combinations during the five-year period ended March 31, 2005 were accounted for under the purchase method and, accordingly, the financial results of these acquired businesses have been included in our financial results below from the indicated acquisition dates: Evity, Inc. in April 2000, OptiSystems Solutions Ltd. in August 2000, Perform, SA in March 2001, Remedy in November 2002, IT Masters International S.A. (IT Masters) in March 2003, Magic Solutions (Magic) in February 2004, Marimba, Inc. (Marimba) in July 2004, Viadyne Corporation in July 2004, Corosoft Technologies in December 2004, Calendra, SA (Calendra) in January 2005 and OpenNetwork Technologies (OpenNetwork) in March 2005.

      The operating results for fiscal 2002 below include impairment losses of $63.3 million related to acquired technology, goodwill and other intangibles. Also, prior to April 1, 2002, we were amortizing our acquired goodwill and intangible assets over three to five-year periods, which reflected the estimated useful lives of the respective assets. As of April 1, 2002, we adopted Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets.” In accordance with this Statement, goodwill and those intangible assets with indefinite lives are no longer amortized but, rather, are tested for impairment annually and when we believe an event or change in circumstance has occurred to reduce the fair value of any of these assets below its carrying value. As such, the operating results for fiscal 2001 and 2002 include amortization of goodwill and certain intangibles of $127.7 million and $129.5 million, respectively, that did not continue after April 1, 2002. The operating results for fiscal 2005 include an impairment loss of $3.7 million related to goodwill assigned to the professional services segment as discussed in Note 5 to the accompanying Consolidated Financial Statements.

      During fiscal 2002 and 2004, we implemented restructuring plans that included the involuntary termination of employees during those years. We also exited leases in certain locations, reduced the square footage required to operate certain locations and relocated some operations to lower cost facilities. The operating results for fiscal 2002 and 2004 below include charges for exit costs of $52.9 million and $110.1 million, respectively, primarily for employee severance and related costs and exited leases. The amount

for fiscal 2002 also includes the write-off of $14.9 million of software assets associated with certain products that were discontinued as a result of the restructuring plan in that year. Additionally, $14.1 million of incremental depreciation expense was recorded in fiscal 2004 related to the changes in estimated depreciable lives for leasehold improvements in locations exited and for certain information technology assets that were eliminated as a result of the restructuring plan in that year.

      The Consolidated Financial Statements for fiscal 2001 were audited by Arthur Andersen LLP, independent public accountants. The Consolidated Financial Statements for fiscal 2002 through fiscal 2005 have been audited by Ernst & Young LLP, an independent registered public accounting firm. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements as of March 31, 2004 and 2005, and for each of the three years in the period ended March 31, 2005, the accompanying notes and the report of the independent registered public accounting firm thereon, which are included elsewhere in this Form 10-K.

Introduction

      We begin Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) with an overview to give the reader management’s perspective on our results for fiscal 2005 and our general outlook for the next fiscal year. This is followed by a discussion of the critical accounting policies that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results. This discussion is followed by a review of our recent, significant acquisitions. In the next section, we discuss our Results of Operations for fiscal 2004 compared to fiscal 2003 and for fiscal 2005 compared to fiscal 2004 and present information about our operating results by quarter for fiscal 2004 and

2005. We then discuss the impact of recently issued accounting pronouncements on our future reported results and provide an analysis of our liquidity and capital resources. Finally, we discuss the risks and uncertainties that we believe may adversely affect our business, financial condition and/or results of operations in the future.

      This MD&A should be read in conjunction with the other sections of this Annual Report on Form 10-K, including Business and Selected Financial Data above and the accompanying Consolidated Financial Statements and notes thereto. MD&A contains a number of forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this filing and particularly in the Certain Risks and Uncertainties section. Our actual results may differ materially from the results indicated by any forward-looking statements.

Overview

      During fiscal 2005 we continued to emphasize the importance of providing the flexibility that our customers need when it comes to structuring their license arrangements. Reflecting these customer preferences, we again saw an increase in the volume of transactions that required deferral of the license fee and recognition of such fees ratably over the terms of the contracts. In fiscal 2005, approximately 37% of our license bookings were deferred as compared to approximately 34% in fiscal 2004. Given the amount of license revenue deferred during fiscal 2005, license bookings remains a key metric for us as it reflects the amount of new license contracts signed during a given period. License bookings can be calculated from our Consolidated Financial Statements by summing current period license revenues plus the net change in deferred license revenue, both calculated according to U.S. generally accepted accounting principles (GAAP). Our license bookings for fiscal 2005 declined 13% from fiscal 2004 as our Distributed Systems Management and Mainframe Management businesses had lower license bookings, which paralleled industry performance. Our Service Management business, the cornerstone of our BSM strategy, experienced strong license bookings growth, primarily due to bookings for products of recently acquired businesses.

      Given our outlook for IT and systems management spending and our expectations for the number and dollar amount of license transactions that will require deferral of revenue, we estimate low single-digit license revenue growth in fiscal 2006. To address our overall profitability, we implemented a restructuring plan subsequent to March 31, 2005 that we believe will allow us to meet our profitability goals by reducing costs and realigning resources to focus on growth areas. As part of this fiscal 2006 plan, we will reduce investment in product areas that are not at acceptable profitability levels and will reduce selling, general and administrative expenses throughout our organization. We expect that the actions taken will allow us to increase investment in our Service Management business, which we believe will provide us future revenue growth, maintain our strong profitability in our Mainframe Management business and improve our profitability in our Distributed Systems Management business. This fiscal 2006 plan is discussed in greater detail under Results of Operations below.

      Another important metric for us is our cash flows from operations, which were $501.9 million for fiscal 2005. We expect to continue to generate significant cash flows from operations, including the positive impact (net of severance payments) we expect from the profitability improvements discussed above as a result of the fiscal 2006 headcount reductions. The issues affecting our cash flows are discussed in greater detail under Liquidity and Capital Resources below.

      In addition to internal development, we continue to look for strategic opportunities to extend our BSM offerings. To this end, we remained acquisitive during fiscal 2005. Our more significant business combinations are discussed in greater detail under Acquisitions below.

      Finally, it is important for our investors to understand that a significant portion of our operating expenses is fixed in the short-term and we plan our expense run-rate based on our expectations of future revenues. In addition, a significant amount of our license transactions are completed during the final weeks and days of each quarter, and therefore we generally do not know whether revenues will have met our expectations until after the end of the quarter. If we have a shortfall in revenues in any given quarter, there is an immediate, sometimes significant, effect on our overall earnings.

Industry Conditions

      The worldwide market for spending on IT solutions remains weak, and we recognize that some of the markets in which we compete are either not growing or are growing at very low rates. However, enterprises around the world have a need for integrated systems management software to manage their complex IT environments. We believe that companies that can provide an integrated suite of solutions that align IT resources with the needs of the overall business will be rewarded with repeat and new customers. While we remain optimistic about our business prospects and continue to believe that we are uniquely positioned to be the leading provider of BSM solutions, 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 smaller software vendors. We compete for new customers and, from time to time, must compete to maintain our relationships with our current customers. This competition can lead to pricing pressure and can affect our margins. We discuss competition in greater detail under Certain Risks and Uncertainties below.

Critical Accounting Policies

      The preparation of consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Our accounting and financial reporting policies are in conformity with accounting principles generally accepted in the U.S. As required by U.S. GAAP, we make and evaluate estimates and judgments on an on-going basis, including those related to revenue recognition, capitalized software development costs, intangible assets, 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 described below with the Audit Committee of our Board of Directors, and the Audit Committee has reviewed the related disclosures below.

      We recognize revenue in accordance with American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, “Software Revenue Recognition,” and SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.” These Statements provide guidance on applying generally accepted accounting principles to recognizing revenue in software transactions. In applying these Statements, we exercise judgment in the determination of the amount of software license, maintenance, enhancement and support (collectively, maintenance) and professional services revenues to be recognized in each accounting period.

      We recognize software license fees upon meeting all of the following four criteria: execution of the signed contract, delivery of the underlying products to the customer and the acceptance of such products by the customer, determination that the software license fees are fixed or determinable and determination that collection of the software license fees is probable. If we determine that any one of the four criteria is not met, we will defer recognition of the software license revenue until the criteria are met, as required by SOPs 97-2 and 98-9. Maintenance revenues are recognized ratably over the term of the arrangement on a straight-line basis. Revenues from license and maintenance transactions that are financed are generally recognized in the same manner as those requiring current payment, as we have a history of offering installment contracts to customers and successfully enforcing original payment terms without making concessions. Because our agents, distributors and resellers (collectively, resellers) act as the principals in the transactions with the end users of our software and the rewards of ownership are passed to the resellers upon the execution of our arrangements with them, we recognize revenues from transactions with resellers on a net basis (the amounts actually received by us from the resellers). In addition, we do not offer a right of return, rotation or price protection in our sales to resellers, and it is our policy to only accept orders from resellers that specifically name an end user. On occasion, we have purchased goods or services for our operations from customers at or about the same time

that we licensed our software to these customers. License revenues from such transactions represent less than one percent of our total license revenues in any period. Revenues from professional services are recognized as the services are performed.

      When several elements, including software licenses, maintenance and professional services, are sold to a customer through a single contract, the license revenues are recognized under the residual method, such that the consideration is allocated to the various other elements included in the agreement based upon the vendor-specific objective evidence of the fair value of those elements, with the residual being allocated to the licenses. Revenues allocated to the undelivered elements of a contract are deferred until such time as those elements are delivered, or in the case of maintenance, such revenues are recognized ratably over the maintenance term. We have established vendor-specific objective evidence of the fair value of our maintenance through the renewal rates in the contractual arrangements with our customers and through independent sales of maintenance at these stated renewal rates. These renewal rates reflect a consistent relationship established by pricing maintenance as a percentage of the discounted or undiscounted license list price. Vendor-specific objective evidence of the fair value of professional services is based on daily rates determined from our contracts for services alone, which are time-and-materials based. Accordingly, software license fees are recognized under the residual method for arrangements in which the software is licensed with maintenance and/or professional services, and where the maintenance and/or professional services are not essential to the functionality of the delivered software. In the event a contract contains multiple elements for which we have not established vendor-specific objective evidence of fair value, all revenues from the contract are deferred until such evidence is established or are recognized on a ratable basis.

      Costs of internally developed software are expensed until the technological feasibility of the software product has been established. Thereafter, software development costs are capitalized until the product’s general release to customers in accordance with SFAS No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.” Capitalized software development costs are then amortized over the product’s estimated economic life beginning at the date of general availability of the product to our customers. Under SFAS No. 86, we evaluate our capitalized software costs at each balance sheet date to determine if the unamortized balance related to any given product exceeds the estimated net realizable value of that product. Any such excess is written off through accelerated amortization in the quarter it is identified. Determining net realizable value as defined by SFAS No. 86 requires that we make estimates and use judgment in quantifying the appropriate amount to write off, if any. Actual amounts realized from the software products could differ from our estimates. Also, any future changes to our product portfolio could result in significant increases to our cost of license revenues as a result of software asset write-offs. The impact of accelerated amortization on fiscal 2003, 2004 and 2005 results is discussed in greater detail under Results of Operations — Cost of License Revenues below.

      When we acquire a business, a portion of the purchase price is typically allocated to acquired technology, in-process research and development and identifiable intangible assets, such as customer relationships. The excess of our cost over the fair value of the net tangible and identifiable intangible assets acquired is recorded as goodwill. The amounts allocated to acquired technology, in-process research and development and intangible assets represent our estimates of their fair values at the acquisition date. The fair values are estimated using the expected present value of future cash flows method of applying the income approach, which requires us to project the related future revenues and expenses and apply an appropriate discount rate. Once the acquired assets are recorded, we amortize the acquired technology and intangible assets with finite lives over their estimated lives. We analyze the realizability of our acquired technology each quarter. All goodwill and those intangibles with indefinite useful lives are not amortized, but rather are tested for impairment annually, and when events or changes in circumstances indicate that the fair value of an intangible asset or a reporting unit with goodwill has been reduced below carrying value. When conducting these realizability and impairment assessments, we are required to estimate future cash flows. The estimates used in

valuing all intangible assets, including in-process research and development, are based upon assumptions believed to be reasonable but which are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur. Accordingly, actual results may differ from the projected results used to determine fair value and to estimate useful lives. Incorrect estimates of fair value and/or useful lives could result in impairment charges and those charges could be material to our consolidated results of operations.

      Our investments primarily consist of marketable debt and equity securities. We account for our marketable investments in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” We regularly analyze our portfolio of marketable securities for impairment. This analysis requires significant judgment. The primary factors considered when determining if an impairment charge must be recorded because a decline in the fair value of a marketable security is other than temporary include whether: (i) the fair value of the investment is significantly below our cost basis; (ii) the financial condition of the issuer of the security has deteriorated; (iii) if a debt security, it is probable that we will be unable to collect all amounts due according to the contractual terms of the security; (iv) the decline in fair value has existed for an extended period of time; (v) if a debt security, such security has been downgraded by a rating agency; and (vi) we have the intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. We have investment policies which are designed to ensure that our assets are invested in capital-preserving securities. However, from time to time, issuer-specific and market-specific events, as described above, could warrant an impairment write down. As the vast majority of our marketable securities are investment-grade debt securities, we believe that any future impairment charges related to these investments will not have a material adverse effect on our consolidated financial position or results of operations. Marketable securities with a fair value below our cost as of March 31, 2004 and 2005 are discussed in greater detail in Note 3 to the accompanying Consolidated Financial Statements.

      We account for the effect of income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” Under SFAS No. 109, income tax expense or benefit is recognized for the amount of taxes payable or refundable for the current year’s results and for deferred tax assets and liabilities related to the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. We are required to make significant assumptions, judgments and estimates to determine (i) our income tax expense or benefit, (ii) our deferred tax assets and liabilities and (iii) whether a valuation allowance should be recorded against our deferred tax assets. Our judgments, assumptions and estimates take into account current tax laws, our interpretation of current tax laws and possible outcomes of current and future audits conducted by domestic (including state) and foreign authorities. These factors significantly impact the amounts we record related to income taxes. Our assumptions, judgments and estimates related to the realizability of our deferred tax assets take into account positive and negative evidence about possible sources of taxable income available under the tax laws to realize the tax benefit, including projections of the amount and category of future taxable income and the amounts that may be realized utilizing prudent and feasible tax-planning strategies. Actual operating results and the underlying amount and category of taxable income in future years could differ from our estimates and the related impact on our income tax expense or benefit could materially affect our consolidated results of operations.

      We are subject to routine corporate income tax audits in multiple jurisdictions and our income tax expense includes amounts intended to satisfy income tax assessments that may result from the examination of our tax returns that have been filed in these jurisdictions. Determining the income tax expense for these potential assessments requires significant judgments and estimates. We evaluate our income tax contingencies in accordance with SFAS No. 5, “Accounting for Contingencies” and have accrued for income tax contingencies that meet both the probable and estimable criteria of SFAS No. 5. We also have various foreign and state income tax exposures that do not meet the probable and/or estimable criteria of SFAS No. 5 and therefore no tax expense has been accrued. The amounts ultimately paid upon resolution of these exposures

could be materially different from the amounts previously included in our income tax expense and therefore could have a material impact on our consolidated results of operations.

Acquisitions

      In November 2002, we acquired the assets of Remedy from Peregrine Systems, Inc. for cash of $355.0 million plus the assumption of certain liabilities of Remedy. In accordance with the purchase agreement, the cash purchase price was adjusted to $347.3 million during fiscal 2004. Integration of Remedy’s industry-leading service desk, change management and asset management capabilities with our broad application and component management solutions enables us to deliver end-to-end, closed-loop service management to customers. The Remedy solutions form the core of our Service Management business which also includes the Magic and Marimba solutions discussed below.

      The acquisition of IT Masters in March 2003 for cash of $42.5 million enhances our competitive position in the service management market. In accordance with the purchase agreement, the cash purchase price was adjusted to $44.5 million during fiscal 2004. IT Masters’ technology combines powerful event automation and service modeling capabilities to transform availability and performance data into detailed knowledge about the status of business services and service level agreements.

      In February 2004, we acquired the assets of Magic from Network Associates for cash of $49.3 million plus the assumption of certain liabilities of Magic. The acquisition strengthens our leadership position in the service management market by increasing our reach to small- and mid-market sized organizations, as Magic had more than 4,000 customers using its service desk solutions.

      The acquisition of Marimba in July 2004 for $230.3 million in cash plus stock options valued at $20.9 million provides new and extended capabilities to our BSM offerings in the areas of change and configuration management, security management and infrastructure management, enabling our customers to rapidly respond to changing business requirements by re-purposing, re-provisioning and updating IT resources to achieve required IT configurations.

      In January 2005, we acquired Calendra for $33.1 million in cash, and in March 2005, we acquired the assets of OpenNetwork for cash of $18.0 million plus the assumption of certain liabilities of OpenNetwork. These two acquisitions complete our transition from being a point product provider in the identity management market to a complete suite provider. The combination of our CONTROL-SA® provisioning solution with Calendra’s state-of-the-art business process centric workflow and directory management capabilities, eliminates integration issues typically faced by customers purchasing individual components from multiple vendors. The OpenNetwork acquisition expands our Identity Management product suite to include browser-based authentication and authorization solutions that enable customers to securely manage access to Web-based applications across multiple business environments.

      These transactions, along with various other immaterial technology acquisitions, have been accounted for using the purchase accounting method, and accordingly, the financial results for these entities have been included in our consolidated financial results since the applicable acquisition dates.

Historical Information

      Historical performance should not be viewed as indicative of future performance, as there can be no assurance that operating income (loss) or net earnings (loss) will be sustained at these levels. For a discussion of factors affecting operating results, see Certain Risks and Uncertainties below.

      The following table sets forth, for the fiscal years indicated, the percentages that selected items in the accompanying Consolidated Statements of Operations and Comprehensive Income (Loss) bear to total revenues.

      We generate revenues from licensing software, providing maintenance, enhancement and support for previously licensed products and providing professional services. We generally utilize written contracts as the means to establish the terms and conditions by which our products, support and services are sold to our customers.

      Fiscal 2004 compared to fiscal 2003. We acquired Remedy in November 2002 and Magic in February 2004, as discussed in Note 2 to the accompanying Consolidated Financial Statements. Excluding the impact of Remedy and Magic revenues subsequent to the acquisition dates, total revenues declined 8% in fiscal 2004 compared to fiscal 2003 primarily as a result of a significant increase in license revenue deferrals. License revenues during the first six months of fiscal 2004 were negatively impacted by reduced IT spending by many of our customers, but customers were more willing to consider new IT projects and to commit to larger transactions during the second half of fiscal 2004. The number of license transactions over $1 million during the second half of fiscal 2004 increased 65% over the prior year, including nine license transactions over $5 million, eight of which are being recognized over the lives of the contracts. See further detail of the impact of the net change in deferred license revenue under Product License Revenues below. Including Remedy and Magic revenues subsequent to the acquisition dates, total revenues increased 7% in fiscal 2004. Product revenue growth was not materially impacted by inflation in fiscal 2004.

      Fiscal 2005 compared to fiscal 2004. We acquired Marimba and other smaller companies in fiscal 2005, as discussed in Note 2 to the accompanying Consolidated Financial Statements. Excluding the impact of companies acquired in fiscal 2004 and 2005, total revenues declined 2% in fiscal 2005 compared to fiscal 2004 primarily as a result of a decline in license revenues. Weakness in IT spending and customer procurement process slowdowns early in fiscal 2005 and lower license bookings for our distributed systems business contributed to this decline. Including revenues of acquired companies, total revenues increased 3% in fiscal 2005. Product revenue growth was not materially impacted by inflation in fiscal 2005.

      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.

      License bookings reflect the amount of new license contracts signed during a given period, and are calculated as recognized license revenues plus the net change in deferred license revenue for the period. License bookings for fiscal 2004 and 2005 were up 9% and down 13%, respectively, from the prior year periods. We closed 86 license transactions over $1 million during fiscal 2005, including two transaction over $10 million, a decrease from 97 such transactions, including four over $10 million, in fiscal 2004 and an increase from 84 such transactions in fiscal 2003, including two transactions over $10 million. The total license bookings value of these 86 transactions in fiscal 2005 was $237.7 million, including amounts recognized and deferred, compared to $287.9 million and $252.3 million for these transactions in fiscal 2004 and 2003, respectively.

      For fiscal 2003, 2004 and 2005, our recognized revenues were impacted by the changes in our deferred license revenue balance as follows:

We expect that our deferred license revenue balance will continue to grow in the near term. The primary reasons for license revenue deferrals include customer transactions that include certain complex contractual terms and conditions, customer transactions that include products with different maintenance pricing methodologies, such as a license covering both Remedy products and other BMC Software products, and customer transactions that include products with differing maintenance periods. In each of these instances, we do not have vendor-specific objective evidence of the fair value of the maintenance and/or professional services in the transaction, which causes the license revenues to be deferred under the residual method of accounting for multiple element arrangements. In addition, we defer license revenues for time-based licenses with terms of less than five years. 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. We anticipate our transactions will increasingly include such contract terms that result in deferral of the related license revenues as we expand our offerings to meet customers’ product, pricing and licensing needs.

      Once it is determined that license revenues for a particular contract must be deferred, based on the contractual terms and application of revenue recognition requirements to those terms, we recognize such license revenue either ratably over the term of the contract or when the revenue recognition criteria are met. Because of this, we generally know the timing of the subsequent recognition of license revenue at the time of deferral. Therefore, the amount of license revenues to be recognized out of the deferred revenue balance in each future quarter is generally predictable, and our total license revenues to be recognized each quarter become more predictable as a larger percentage of those revenues come from the deferred license revenue balance. As of March 31, 2005, the average remaining life of the deferred license revenue balance was approximately three years. Of the total deferred license revenue balance at March 31, 2005, we estimate that we will recognize license revenues of $170.3 million, $117.7 million and $119.2 million, for fiscal 2006, fiscal 2007 and fiscal 2008 and thereafter, respectively.

      Our domestic operations generated 50%, 45% and 47% of total license revenues in fiscal 2003, 2004 and 2005, respectively. Domestic license revenues decreased 15% from fiscal 2003 to fiscal 2004 and 1% from fiscal 2004 to fiscal 2005. Excluding the impact of acquisitions, domestic license revenues decreased 30% in fiscal 2004 and 11% in fiscal 2005. Domestic license revenues for the mainframe data management product line declined 20% and 11% in fiscal 2004 and 2005, respectively. Domestic license revenues for the PATROL product line declined 23% and 28% in fiscal 2004 and 2005, respectively. The overall decline for fiscal 2004 was primarily due to the impact of deferred license revenues as discussed above, as well as an overall decrease in license bookings in the region. In fiscal 2005, the 32% increase in domestic license revenues for our Service Management products only partially offset the revenue declines above. Domestic license bookings were also down in fiscal 2005.

      International license revenues represented 50%, 55% and 53% of total license revenues in fiscal 2003, 2004 and 2005, respectively. International license revenues increased 5% from fiscal 2003 to fiscal 2004 and decreased 9% from fiscal 2004 to fiscal 2005. Excluding the impact of acquisitions, international license revenues decreased 5% in fiscal 2004 and 12% in fiscal 2005. International license revenues increased 10% for our PATROL products and 8% for our scheduling and output management products in fiscal 2004. These increases were more than offset by a 16% decrease in our mainframe data management products and a 18% decrease for our MAINVIEW products. These decreases were primarily due to the impact of increased deferred license revenue, as discussed above. In fiscal 2005, the declines were across all product lines other than service management and resulted primarily from weakness in certain international locations. Foreign currency exchange rate changes increased international license revenues 9% and 4% for fiscal 2004 and 2005, respectively, net of hedging. Excluding this currency impact, international license revenues decreased 4% and 13% for fiscal 2004 and 2005, respectively.

      Maintenance revenues represent the ratable recognition of fees to enroll licensed products in our software maintenance, enhancement and support program. Maintenance 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. Annual maintenance fees are based on a percentage of the undiscounted license list price for Remedy and Magic products and the discounted license list price for other BMC Software products. Customers are generally entitled to reduced annual maintenance percentages for entering into long-term maintenance contracts. The majority of our maintenance revenues are generated by such long-term contracts. Maintenance revenues also include the ratable recognition of the bundled fees for any initial maintenance services covered by the related license agreement.

      Maintenance revenues increased 19% in fiscal 2004 and 9% in fiscal 2005, primarily as a result of the additional maintenance revenue associated with acquired products and the continuing growth in the base of installed Service Management products. Maintenance fees increase with new license and maintenance agreements and as existing customers install our products on additional processing capacity or add users. However, discounts on licensed products tend to increase at higher levels of processing capacity, so that maintenance fees on a per unit of capacity basis are typically reduced in enterprise license agreements. These discounts, combined with an increase in long-term maintenance contracts with reduced maintenance percentages and our license bookings performance excluding our Service Management products, have led to low growth rates for our maintenance revenues excluding our Service Management products. Of the total deferred maintenance revenue balance at March 31, 2005, we expect to recognize maintenance revenues of $563.4 million, $320.1 million, and $309.8 million for fiscal 2006, fiscal 2007 and fiscal 2008 and thereafter, respectively.

* not meaningful

      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, distributed data management, scheduling and output management solutions. The Service Management product category includes our service, change and asset management, IT discovery and software configuration management solutions. The Identity Management product category includes products that facilitate user administration and provisioning, password administration, enterprise directory management, web access control and audit and compliance management.

      Our Mainframe Management solutions combined represented 48%, 39% and 36% of total software revenues for fiscal 2003, 2004 and 2005, respectively. Total software revenues for this group declined 12% from fiscal 2003 to fiscal 2004 and 7% from fiscal 2004 to fiscal 2005. In fiscal 2004, license and maintenance revenues decreased for the mainframe data management product line primarily due to increased deferrals of license revenues along with decreased license bookings due to increased competition and slower capacity growth. MAINVIEW license and maintenance revenues also declined in fiscal 2004 due to increased discounts. The decline in fiscal 2005 included license and maintenance revenue declines for the MAINVIEW product line. Our past success in displacing IBM’s Candle products has reduced current opportunities for this product line. At the same time, customer demand for capacity has slowed. Mainframe data management license revenues also decreased consistent with the overall trends in the mainframe market.

      Our Distributed Systems Management solutions combined contributed 44%, 39% and 37% of total software revenues for fiscal 2003, 2004 and 2005, respectively. Total software revenues for this group declined 3% from fiscal 2003 to fiscal 2004 and 4% from fiscal 2004 to fiscal 2005. For fiscal 2004, a large increase in the net change in deferred license revenues for the PATROL and Scheduling & Output Management product lines offset the increases in license bookings for these products. This, together with a decrease in license revenues for our distributed systems data management product line more than offset the increase in maintenance revenues for the PATROL and scheduling & output management product lines. For fiscal 2005, license bookings were down across all product lines in this category, resulting in decreased license revenues

which more than offset maintenance revenue increases for all product lines. The decline in license bookings was primarily for our Distributed Systems Data Management products as a result of increased competition from database providers in this market and for our PATROL products as we are undergoing a product transition for this product line, integrating our agent-based and agentless PATROL technologies.

      Our Service Management solutions contributed 6% of total software revenues for fiscal 2003, including Remedy revenues for the period from the acquisition date of November 20, 2002 through March 31, 2003 and the impact of the purchase accounting write-down of the Remedy acquisition date deferred maintenance revenue. Revenues from our Service Management products contributed 19% and 26% of total software revenues for fiscal 2004 and 2005, respectively. As the acquisition of Remedy was completed during the third quarter of fiscal 2003, a comparison of fiscal 2003 to 2004 is not meaningful. Total software revenues for this group increased 39% from fiscal 2004 to fiscal 2005 primarily due to the acquisitions of Magic and Marimba in the fourth quarter of fiscal 2004 and the second quarter of fiscal 2005, respectively, and growth of Remedy’s core business.

      Our Identity Management solutions contributed 3%, 2% and 2% of total software revenues for fiscal 2003, 2004 and 2005, respectively. Total software revenues for this group decreased 17% from fiscal 2003 to fiscal 2004 and decreased 14% from fiscal 2004 to fiscal 2005. The decrease in fiscal 2004 was a result of increased competitive pressures. An increase in maintenance revenues was more than offset by a decline in license revenues for the year. During fiscal 2005, the identity management market continued to experience consolidation and, as such, many of our competitors were able to offer integrated solution suites, which customers are choosing over the point products we provided. Our acquisitions of Calendra in January 2005 and OpenNetwork in March 2005 completed our transition from being a point product provider in the identity management market to a complete suite provider.

      Professional services revenues, representing fees from implementation, integration and education services performed during the periods represented 6% of total revenues for fiscal 2003, 2004 and 2005. Professional services revenues remained flat from fiscal 2003 to fiscal 2004 and increased 9% from fiscal 2004 to fiscal 2005. Excluding the impact of Remedy and Magic revenues subsequent to their acquisition dates, professional services revenues declined by 14% in fiscal 2004. The decline in fiscal 2004 was primarily the result of our decreased license revenues, which depressed demand for our implementation and integration services. The increase in fiscal 2005 is primarily a result of additional revenues from Service Management acquisitions.

      During fiscal 2004, we implemented a restructuring plan that included the involuntary termination of approximately 785 employees, primarily during the first half of the year. The workforce reduction was across all functions and geographies and affected employees were provided cash separation packages. We also exited leases in certain locations, reduced the square footage required to operate some locations and relocated some operations to lower cost facilities. Charges for exit costs of $110.1 million were recorded in fiscal 2004, for employee severance and related costs and exited leases. Additionally, $14.1 million of incremental depreciation expense was recorded during the year, related to changes in estimated depreciable lives for leasehold improvements in locations exited and for certain information technology assets that were eliminated as a result of the plan. These changes in estimated lives reduced basic and diluted earnings per share by $0.05 for fiscal 2004. The expenses related to the exit activities are reflected in the accompanying Consolidated Statements of Operations and Comprehensive Income (Loss) for fiscal 2004 as follows:

      As of March 31, 2005, $41.2 million of severance and facilities costs related to actions completed under the plan remained accrued for payment in future periods, as follows:

      The amounts accrued at March 31, 2005 related to facilities costs represent the remaining fair value of lease obligations for exited locations, as determined at the cease-use dates for those facilities, net of estimated sublease income that could be reasonably obtained in the future, and will be paid out over the remaining lease terms, the last of which ends in fiscal 2011. We do not expect any significant additional severance or facilities charges related to this plan subsequent to March 31, 2005, other than potential adjustments to lease accruals based on actual subleases differing from estimates.

      Beginning in fiscal 2005, we have presented the cost of license revenues separately in the accompanying Consolidated Financial Statements. All periods presented have been reclassified for consistency. The cost of license revenues is primarily comprised of the amortization of capitalized software development costs and the amortization of acquired technology obtained through business combinations. The cost of license revenues for fiscal 2004 and 2005 also included a portion of the severance and facilities costs related to exit activities discussed under Fiscal 2004 Exit Activities and Related Costs above and in Note 11 to the accompanying Consolidated Financial Statements. The cost of license revenues was 27%, 29% and 24% of license revenues for fiscal 2003, 2004 and 2005, respectively, and consisted of the following:

      As discussed under Critical Accounting Policies above, we capitalize software development costs in accordance with SFAS No. 86. The following table summarizes the amounts capitalized and amortized during fiscal 2003, 2004 and 2005. 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.

      We reviewed our product portfolio during fiscal 2002 and fiscal 2003 and discontinued certain products. To the extent that there were any capitalized software development costs remaining on the balance sheet related to these products, we accelerated the amortization to write off these balances. The continued need to accelerate amortization to maintain our capitalized software costs at net realizable value, the results of the valuation performed for the Remedy acquisition that indicated a three-year life was appropriate for that acquired technology and changes in the average life cycles for certain of our software products caused us to evaluate the estimated economic lives for our internally developed software products. As a result of this evaluation, we revised the estimated economic lives of certain products as of January 1, 2003, such that most products at that date would be amortized over an estimated life of three years. These changes in estimated economic lives resulted in an additional $12.4 million and $36.8 million of amortization expense in fiscal 2003 and fiscal 2004, respectively, and reduced basic and diluted earnings per share for the years ended March 31, 2003 and 2004 by $0.03 per share and $0.14 per share, respectively.

      The decrease in software development cost capitalization from fiscal 2003 to fiscal 2004 is due to the overall reduction in research and development headcount in early fiscal 2004, expansion of our operations into different locations and two significant products becoming generally available during the third fiscal quarter of 2004. During fiscal 2005, capitalization has increased from those reduced levels as development has increased, especially in the Service Management area, including acquisitions. Lower amounts capitalized in fiscal 2004, coupled with mature products becoming fully amortized and reduced amounts of accelerated amortization, have led to reduced amortization expense during fiscal 2005.

      Beginning in fiscal 2005, we have presented the cost of maintenance revenues separately in the accompanying Consolidated Financial Statements. All periods presented have been reclassified for consistency. The cost of maintenance revenues is primarily comprised of the costs associated with the customer support and research and development personnel that provide maintenance, enhancement and support services to our customers. The cost of maintenance revenues for fiscal 2004 and 2005 also included a portion of the severance and facilities costs related to exit activities discussed under Exit Activities and Related Costs above and in Note 11 to the accompanying Consolidated Financial Statements. The cost of maintenance was 27%, 28% and 22% of maintenance revenues for fiscal 2003, 2004 and 2005, respectively, and consisted of the following:

      As a percent of maintenance revenues, cost of maintenance revenues increased in fiscal 2004 and decreased in fiscal 2005 primarily as a result of the expenses related to exit activities in fiscal 2004, as discussed above. The headcount reductions associated with the exit activities were completed during the first half of fiscal 2004 and therefore the cost of maintenance services in the table above reflects the positive impact of these reductions for a portion of fiscal 2004. A full year of benefit was realized in fiscal 2005, which was partially offset by increases in costs for headcount added during the year from expansion into different locations and from acquisitions.

      The cost of professional services consists primarily of personnel costs and third-party fees associated with implementation, integration and education services that we provide to our customers, and the related infrastructure to support this business. Cost of professional services decreased 9% from fiscal 2003 to 2004 and increased 16% from fiscal 2004 to fiscal 2005. Excluding the impact of Remedy and Magic expenses subsequent to their acquisition dates, cost of professional services declined 19% from fiscal 2003 to fiscal 2004. Excluding the impact of Remedy and Magic expenses and costs related to exit activities, cost of professional services declined 22% from fiscal 2003 to fiscal 2004. This decrease resulted primarily from lower headcount throughout fiscal 2004. Excluding the costs related to exit activities in fiscal 2004, the cost of professional services increased 20% from fiscal 2004 to fiscal 2005 primarily due to increased professional services revenues and increased utilization of third-party implementation services.

      Our selling and marketing expenses primarily include personnel and related costs, sales commissions and costs associated with advertising, industry trade shows and sales seminars, and represented 38%, 43% and 38% of total revenues in fiscal 2003, 2004 and 2005, respectively. Selling and marketing expenses increased 22% from fiscal 2003 to fiscal 2004 and decreased 9% from fiscal 2004 to fiscal 2005. Excluding the impact of Remedy and Magic expenses subsequent to their acquisition dates, selling and marketing expenses increased 9% in fiscal 2004. Excluding the impact of Remedy and Magic expenses and costs related to exit activities, selling and marketing expenses decreased 2% from fiscal 2003 to fiscal 2004. This decline was primarily related to decreases in personnel and travel expenses as a result of the headcount reductions early in the year as discussed above, which were slightly offset by an increase in commissions, sales seminars and advertising expenses. The increase in commission expense in fiscal 2004 occurred late in the fiscal year when the actual mix of the license and maintenance components of our largest sales transactions differed from the historical

norm, upon which the fiscal 2004 commission plan was established. Because of this shift in the license and maintenance mix, the commission rate effectively increased during this time period.

      Selling and marketing expenses declined in fiscal 2005 primarily as a result of the costs related to exit activities in the prior year and decreased commissions expense partially offset by increased headcount and travel costs, including acquisitions. Commission expense is down as a result of changes in our commission plan that led to increased commissions on maintenance bookings which are initially deferred and then are expensed as the related revenues are recognized. For fiscal 2003, 2004 and 2005, commission expense was impacted by the changes in our deferred commissions balance (i.e., the net impact of commissions deferred and commissions recognized out of the deferred balance) as follows:

      Research and development 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 computer hardware/ software costs, telecommunications and personnel expenses necessary to maintain our research and development data processing center. Research and development expenses increased 20% from fiscal 2003 to fiscal 2004 and decreased 14% from fiscal 2004 to fiscal 2005. Excluding the impact of costs related to exit activities in fiscal 2004, research and development expenses increased 7% from fiscal 2003 to fiscal 2004, primarily because fiscal 2004 included a full year of Remedy costs, while fiscal 2003 included only the expenses for the four months after the acquisition date. This was partially offset by decreased personnel costs for the rest of BMC Software as a result of the headcount reductions early in the year as discussed above. Research and development expenses declined in fiscal 2005 primarily as a result of the costs related to exit activities in the prior year. Excluding the exit costs in fiscal 2004, research and development costs decreased 4%. While we had personnel growth in lower cost locations and from acquisitions, research and development expenses declined because more software development costs required capitalization, as discussed under Cost of License Revenues above.

      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 increased 21% from fiscal 2003 to fiscal 2004 and 22% from fiscal 2004 to fiscal 2005. Excluding the impact of Remedy and Magic expenses subsequent to their acquisition dates, general and administrative expenses increased 16% in fiscal 2004. Excluding the impact of Remedy and Magic expenses and costs related to exit activities, general and administrative expenses increased 13% in fiscal 2004. The increase included higher consulting fees, primarily related to Sarbanes-Oxley compliance and an ongoing infrastructure software implementation, higher legal and professional fees and an increase in bad debt expense related to maintenance billings. Excluding the exit costs in fiscal 2004, general and administrative expenses increased 25% in fiscal 2005. This increase included higher professional fees, consisting of legal, accounting and consulting fees primarily due to Sarbanes-Oxley Section 404 compliance efforts, and higher personnel costs, a significant portion of which related to expanded accounting staff. Total third-party fees incurred in fiscal 2005 related to Sarbanes-Oxley Section 404 compliance were $19.0 million, and we will continue to incur such fees at a lower level in fiscal 2006. The increase for fiscal 2005 also included the write-off of $11.4 million of costs capitalized for an internal-use

information technology project that was terminated before completion during the year and other internal-use software assets.

      Under the purchase method of accounting for our business combinations, portions of the purchase prices were allocated to intangible assets, including customer relationships, tradenames and non-compete agreements. We are amortizing certain of these intangible assets over two to four-year periods, which reflect the estimated useful lives of the respective assets. The increases in amortization expense in fiscal 2004 and 2005 were primarily due to the acquisitions during those years.

      During fiscal 2003, 2004 and 2005, we wrote off acquired in-process research and development (IPR&D) totaling $12.0 million in connection with the acquisition of Remedy (3% of the purchase price), $1.0 million in connection with the acquisition of Magic (2% of the purchase price) and $4.0 million in connection with the acquisitions of Viadyne, Calendra and OpenNetwork (collectively, 7% of the aggregate purchase price), respectively. The amounts allocated to IPR&D represent the estimated fair values, based on risk-adjusted cash flows and historical costs expended, related to incomplete research and development projects. At the dates of acquisition, the development of these projects had not yet reached technological feasibility, and the research and development in progress had no alternative future uses. Accordingly, these costs were expensed as of the acquisition dates, during fiscal 2003, 2004 and 2005.

      In making the purchase price allocations to IPR&D, we considered present value calculations of income, analyses of project accomplishments and remaining outstanding items, assessments of overall contributions, as well as project risks. The values assigned to purchased in-process technology were determined by estimating the costs to develop the acquired technology into commercially viable products, estimating the resulting net cash flows from the projects, and discounting the net cash flows to their present value. The revenue projections used to value the in-process research and development were based on estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by us and our competitors. The resulting net cash flows from such projects are based on our estimates of cost of sales, operating expenses and income taxes from such projects.

      A risk-adjusted discount rate was applied to the cash flows of each of the products’ projected income streams for the five years following the acquisition. These discount rates assume that the risk of revenue streams for new technology is higher than that of existing revenue streams. The discount rates used in the present value calculations were generally derived from a weighted average cost of capital, adjusted upward to reflect the additional risks inherent in the development life cycle, including the useful life of the technology, profitability levels of the technology and the uncertainty of technology advances that are known at the transaction date. Product-specific risk includes the stages of completion of each product, the complexity of the development work completed to date, the likelihood of achieving technological feasibility and market acceptance.

      In the present value calculation for Remedy, aggregate revenues for developed, in-process and future products were estimated to grow at a compounded annual growth rate of approximately 15% for the five years following acquisition, assuming the successful completion and market acceptance of the major current and future research and development programs. The estimated revenues for the in-process projects were expected to peak within three years of acquisition and then decline sharply as other new products and technologies are expected to enter the market.

      The estimates used in valuing IPR&D were based upon assumptions believed to be reasonable but which are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur. Accordingly, actual results may differ from the projected results used to determine fair value.

      We test our goodwill for impairment during the fourth quarter of each fiscal year, after the annual planning process is complete. Primarily due to recent operating results, including the increased use of third-party implementation services, the projected profitability and cash flows of the professional services segment were reduced. As a result, the goodwill of $3.7 million assigned to the professional services segment was considered totally impaired during fiscal 2005. The fair value of the professional services reporting unit was estimated using the expected present value of future cash flows method of applying the income approach.

      We settled our dispute with Nastel Technologies, Inc. during fiscal 2005. The settlement payment of $11.3 million covers all claims involved in this action.

      While we remained focused on expense control throughout fiscal 2005, we implemented a plan subsequent to March 31, 2005 that we expect will allow us to meet our profitability goals by reducing costs and realigning resources to focus on growth areas. The fiscal 2006 plan includes the elimination of 825 to 875 employee positions around the world. We have reduced investment in product areas that are not at acceptable profitability levels and have reduced selling, general and administrative expenses throughout our organization. We expect that the actions taken will allow us to increase investment in our Service Management business, which we believe will provide us future revenue growth, maintain our strong profitability in our Mainframe Management business and improve our profitability in our Distributed Systems Management business. Combining the expected annual cost savings from these actions and the increased investment in growth areas, we estimate that we will achieve an annual expense reduction of approximately $100 million relative to our projected operating expenses before our restructuring activities.

      Other income, net, consists primarily of interest earned on cash, cash equivalents, marketable securities and finance receivables, rental income on owned facilities, gains and losses on marketable securities and other investments and interest expense on capital leases. Other income, net, increased 44% from fiscal 2003 to fiscal 2004 and increased 8% from fiscal 2004 to fiscal 2005. The increase in fiscal 2004 is primarily due to the $2.0 million gain on the licensing of our PATROL Storage Manager product to EMC Corporation during the year, increased investment income, including the realized recovery of marketable securities previously written down, and an increase in rental income, which were slightly offset by $4.0 million of impairment charges related to cost-basis investments. The increase in other income, net for fiscal 2005 is primarily due to an $8.0 million gain realized on the sale of previously securitized finance receivables as discussed in Note 4 to the accompanying Consolidated Financial Statements and impairment charges. These increases were partially offset by net losses of $1.6 million on marketable securities in fiscal 2005 and a decrease as a result of the non-recurring gain on PATROL Storage Manager in the prior year, as discussed above.

      We recorded an income tax expense of $21.3 million in fiscal 2003, an income tax benefit of $2.6 million in fiscal 2004 and an income tax expense of $22.9 million in fiscal 2005. Our effective tax rates were 31%, 9% and 23% for fiscal 2003, 2004 and 2005, respectively. Our effective tax rate is impacted primarily by the tax effect attributable to our foreign earnings (net of U.S. tax consequences), changes in the valuation allowance recorded against our deferred tax assets, benefits attributable to the extraterritorial income exclusion and non-recurring adjustments to our aggregate net liabilities for income taxes. In fiscal 2005, the most significant item impacting our effective tax rate is a tax benefit of $26.7 million recorded as a result of the reversal of a valuation allowance that was previously recorded against our deferred tax assets, as discussed below. The other significant item impacting our fiscal 2005 effective tax rate is an expense of $11.1 million to adjust our aggregate net liabilities for income taxes, withholding taxes and income tax exposures that were found to be

understated after a thorough analysis of all of our income tax accounts in the first quarter of fiscal 2005. For a detailed analysis of the differences between the statutory and effective income tax rates, see Note 6 to the accompanying Consolidated Financial Statements.

      In evaluating our ability to realize our net deferred tax asset, we consider all available evidence, both positive and negative, including our past operating results, the existence of cumulative losses in the most recent fiscal years, tax planning strategies and our forecast of future taxable income. In considering these sources of taxable income, we must make certain assumptions and judgments that are based on the plans and estimates we use to manage our underlying business. Changes in our assumptions and estimates may materially impact our income tax expense. During fiscal 2005, we evaluated all available positive and negative evidence and concluded that a valuation allowance was no longer necessary, except for the specific items totaling $5.4 million discussed below. The following evidence influenced the change in our assessment from fiscal 2004 to fiscal 2005. We generated positive earnings before taxes in fiscal 2005 and are no longer in a cumulative loss position when aggregating the fiscal 2003, 2004 and 2005 consolidated results of operations. In fiscal 2004, we generated losses before taxes and were in a cumulative loss position. In addition, we can support a large portion of our net deferred tax asset through the evaluation of prudent and feasible tax planning strategies that would result in realization of deferred tax assets. Our tax planning strategies primarily involve the acceleration of royalty and cost-sharing payments under agreements that are currently in place between BMC Software and its foreign affiliates. Under these agreements, the acceleration of such payments is at our sole discretion. Each year we must evaluate the amount of domestic deferred tax assets that could be supported by the acceleration of these taxable income streams. Based on the assumptions and estimates that were determined in conjunction with the preparation of our fiscal 2005 operating results, we believe that these tax planning strategies support more deferred tax assets than they supported at the end of fiscal 2004. In our evaluation we also considered negative evidence such as our inability to carryback losses to earlier tax years. After a thorough evaluation of both the positive and negative evidence, we concluded that a valuation allowance is no longer necessary beyond the items discussed below and that our net deferred tax asset as of March 31, 2005 is supportable. Consistent with this judgment, we recorded a $26.7 million tax benefit as part of the total income tax expense for fiscal 2005, for the reversal of the valuation allowance previously recorded against our deferred tax assets. We also reduced our valuation allowance and recorded an increase to additional paid-in capital of $13.8 million for tax benefits attributable to non-qualified stock option exercises in prior years that resided in the net operating loss carryforwards that were utilized in fiscal 2005.

      SFAS No. 109 also requires the evaluation of the character of income that generated our deferred tax assets. Our deferred tax assets include losses that are attributable to capital transactions that require future taxable income of a specific character in order to utilize. We have maintained a valuation allowance against this specific asset as we do not have positive evidence that supports the utilization of the capital loss. We have also maintained a valuation allowance against a research and development credit acquired as part of the Marimba acquisition due to various uncertainties regarding the utilization of this specific asset. We increased our valuation allowance and recorded an increase to goodwill of $2.7 million related to this acquired asset. If this valuation allowance is reduced in a future year, a related reduction to goodwill would be recognized. The combined valuation allowance attributable to these two specific items is $5.4 million. We will continue to evaluate the realizability of our net deferred tax asset on a quarterly basis. See Note 6 to the accompanying Consolidated Financial Statements for more information regarding our deferred tax assets.

      We provide for the U.S. income tax effect on the earnings of foreign subsidiaries unless they are considered indefinitely re-invested outside of the United States. At March 31, 2005, we recorded a deferred tax asset of $3.8 million related to excess foreign tax credits that are available to offset our U.S. income taxes on the earnings we do not consider indefinitely re-invested under APB Opinion No. 23. As of March 31, 2005, the cumulative earnings upon which U.S. income taxes have not been provided were approximately $770 million. If these earnings were repatriated to the United States, or they were no longer determined to indefinitely re-invested under APB Opinion No. 23, the potential deferred tax liability for these earnings would be approximately $249 million without the special one-time tax deduction discussed below, assuming full utilization of the foreign tax credits associated with these earnings.

      On October 22, 2004, President Bush signed the American Jobs Creation Act of 2004 (the Act), which provides for a special one-time tax deduction of 85% of certain foreign earnings that are repatriated. As of March 31, 2005, we had not decided on whether, and to what extent, we might repatriate foreign earnings under the Act, and accordingly, the accompanying Consolidated Financial Statements do not reflect any provision for taxes on unremitted foreign earnings available for repatriation under the Act. Since that time, however, the U.S. Treasury Department issued additional guidance interpreting the Act and we have completed our analysis of the Act. In June 2005, our Board of Directors approved a plan to repatriate approximately $717 million of foreign earnings and, accordingly, we will record a tax liability and associated tax expense of approximately $36 million related to the planned repatriation during the quarter ending June 30, 2005.

      As of March 31, 2005, we have foreign tax credit carryforwards of $17.3 million that will expire between 2012 and 2014 and research and development tax credit carryforwards of $4.5 million (net of a $2.7 million valuation allowance) that will expire in 2021. We also have alternative minimum tax credit carryforwards of $5.3 million that are not subject to expiration.

      During fiscal 2005, we and the Internal Revenue Service Appeals Division (IRS Appeals) resolved our income tax audits for the fiscal years ended March 31, 1998 and 1999. Accordingly, we have now closed all federal corporate income tax audit issues for years prior to fiscal 2000. The settlement with IRS Appeals did not have a material impact on our consolidated financial position or results of operations.

      The IRS has completed its examination of our federal income tax returns filed for the tax years ended March 31, 2000 and 2001 and issued its Revenue Agent Report. We have filed our protest letter and are currently working with IRS Appeals to resolve the issues raised at examination. We believe that we have meritorious defenses to the proposed adjustments, that adequate provisions for income taxes have been made and, therefore, that the ultimate resolution of the issues will not have a material adverse impact on our consolidated financial position or results of operations. During the quarter ended September 30, 2004, the IRS commenced the examination of our fiscal 2002 and 2003 federal income tax returns. We believe that our income tax provisions adequately reflect the proper amount of income tax associated with these arrangements.

Quarterly Results

      The following table sets forth certain unaudited quarterly financial data for fiscal 2004 and 2005. This information has been prepared on the same basis as the accompanying Consolidated Financial Statements and all necessary adjustments have been included in the amounts below to present fairly the selected quarterly information when read in conjunction with the accompanying Consolidated Financial Statements and notes thereto.

Recently Issued Accounting Pronouncements

      In March 2004, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF Issue No. 03-1 provides guidance on evaluating other-than-temporary impairment for marketable debt and equity securities accounted for under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” as well as non-marketable equity securities accounted for under the cost method. The consensus includes a basic three-step model to evaluate whether an investment is other-than-temporarily impaired. In September 2004, the FASB issued FASB Staff Position (FSP) No. EITF Issue 03-1-1, “Effective Date of Paragraphs 10 - 20 of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” This FSP delays the effective date for the measurement and recognition guidance contained in EITF Issue No. 03-1 until the FASB staff provides applicable implementation guidance. This delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing authoritative literature. During the period of delay, an entity holding investments must continue to apply relevant other-than-temporary guidance. We do not expect the new guidance to have a material effect on our consolidated financial position or results of operations.

      In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets,” as an amendment of APB Opinion No. 29, “Accounting for Nonmonetary Transactions.” This Statement addresses the measurement of exchanges of nonmonetary assets. It eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in APB Opinion No. 29 and replaces it with an exception for exchanges that do not have commercial substance. This Statement specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of this Statement are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005 and must be applied prospectively. We do not expect that the adoption of SFAS No. 153 will have a material effect on our consolidated financial position or results of operations.

      In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment,” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123(R) supersedes APB Opinion No. 25 and amends SFAS No. 95, “Statement of Cash Flows.” In April 2005, the SEC issued a rule delaying the required adoption date for SFAS No. 123(R) to the first interim period of the first fiscal year beginning on or after June 15, 2005. Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. Pro forma disclosure is no longer an alternative. SFAS No. 123(R) permits adoption using one of two methods: (1) a “modified prospective” method in which compensation cost is recognized beginning on the effective date based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and based on SFAS No. 123 for all awards granted to employees prior to the effective date that remain unvested on the effective date or (2) a “modified retrospective” method which includes the requirements of the modified prospective method, but also permits entities to restate all periods presented or prior interim periods of the year of adoption based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures. We expect to adopt SFAS No. 123(R) using the modified prospective method as of April 1, 2006, the beginning of our fiscal 2007. We are currently evaluating option valuation methodologies and assumptions in light of FAS 123(R) and the SEC guidance; the methodologies and assumptions we ultimately use to adopt FAS 123(R) may be different than those currently used as discussed in Note 1(l) to the accompanying Consolidated Financial Statements.

      As permitted by SFAS No. 123, we currently account for share-based payments to employees using APB Opinion No. 25’s intrinsic value method and, as such, generally recognize no compensation cost for employee stock options, as the exercise prices of options granted are generally equal to the quoted market price of our common stock on the date of grant, except in limited circumstances when stock options have been exchanged in a business combination. Accordingly, the adoption of SFAS No. 123(R)’s fair value method will have a significant impact on our results of operations. The impact of adoption of SFAS No. 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future.

However, had we adopted SFAS No. 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net earnings (loss) and earnings (loss) per share in Note 1(l) to the accompanying Consolidated Financial Statements. SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. In general, this requirement would reduce net operating cash flows and increase net financing cash flows in periods after adoption. While we cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the excess tax deductions recorded in fiscal 2005 were $17.3 million. We did not recognize any such tax benefits for fiscal 2003 and 2004.

      In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3.” This Statement changes the requirements for the accounting for and reporting of a change in accounting principle. It applies to all voluntary changes in accounting principle and to those changes required by an accounting pronouncement when such a pronouncement does not include specific transition provisions. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change.

Liquidity and Capital Resources

      One of our major goals is to optimize our capital structure. The key metrics we focus on in analyzing the strength of our financial position are summarized in the tables below:

      The table below aggregates certain line items from the accompanying Consolidated Statements of Cash Flows to present the key items affecting our cash flows from operating activities:

      The table below aggregates certain line items from the accompanying Consolidated Statements of Cash Flows to present the key items affecting our cash flows from investing activities:

      The table below aggregates certain line items from the accompanying Consolidated Statements of Cash Flows to present the key items affecting our cash flows from financing activities:

      At March 31, 2005, our cash, cash equivalents and marketable securities were $1.3 billion, an increase of $70.1 million from the March 31, 2004 balance. As discussed in more detail below, this increase is primarily due to positive operating cash flow, which was somewhat offset by the cash funding for the Marimba, Calendra and other acquisitions and treasury stock purchases. Approximately 82% of our cash, cash equivalents and marketable securities at March 31, 2005 is held in international locations and was largely generated from our international operations. Our international operations have generated approximately $770 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 $249 million without the special one-time tax deduction discussed below; however, we have not provided a deferred tax liability on any portion of the $770 million as these earnings were considered permanently invested outside of the U.S. During fiscal 2003, 2004 and 2005, we utilized cash held in international locations to fund a portion of the Remedy purchase price, based upon the valuation of the foreign assets of Remedy acquired, and the IT Masters, Magic and Calendra purchase prices.

      On October 22, 2004, President Bush signed the American Jobs Creation Act of 2004 (the Act), which provides for a special one-time tax deduction of 85% of certain foreign earnings that are repatriated. As of March 31, 2005, we had not decided on whether, and to what extent, we might repatriate foreign earnings under the Act, and accordingly, the accompanying Consolidated Financial Statements do not reflect any provision for taxes on unremitted foreign earnings available for repatriation under the Act. Since that time, however, the U.S. Treasury Department issued additional guidance interpreting the Act and we have completed our analysis of the Act. In June 2005, our Board of Directors approved a plan to repatriate approximately $717 million of foreign earnings and, accordingly, we will record a tax liability and associated tax expense of approximately $36 million related to the planned repatriation during the quarter ending June 30, 2005.

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

      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 significant portion of our finance receivables, enabling us to collect cash sooner and remove credit risk. The finance receivables are sold to third-party financial institutions on a non-recourse basis. We record such transfers of beneficial interests in finance receivables to third-party financial institutions as sales of such finance receivables when we have surrendered control of such receivables, including determining that such assets have been isolated beyond our reach and the reach of our creditors. We have not guaranteed the transferred receivables and have no obligation upon default. During fiscal 2003, 2004 and 2005, we transferred $376.8 million, $288.7 million and $247.4 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 may also reduce our ability to transfer finance receivables in the future and may reduce our cash flow from operations in the near term.

      As discussed in Note 4 to the accompanying Consolidated Financial Statements, prior to fiscal 2004, we securitized trade finance receivables from customers with investment-grade credit ratings through two commercial paper conduit entities sponsored by third-party financial institutions. In April 2004, one of these third-party entities sold its interests in our outstanding securitized finance receivables to the other third-party entity, such that the senior interests in all of our outstanding securitized finance receivables were held by one

entity. In December 2004, we purchased the senior interests from this entity at fair value, effectively terminating our securitization arrangements. We simultaneously transferred the outstanding finance receivables that had previously been securitized to an unaffiliated financial institution on a non-recourse basis through our existing financial subsidiary. This transfer was recorded as a sale in accordance with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.”

      Our Board of Directors has authorized a $1.0 billion stock repurchase program ($500.0 million authorized in April 2000 that was increased by $500.0 million in July 2002). During fiscal 2005, we purchased 5.3 million shares for $87.0 million. From the inception of the repurchase plan through March 31, 2005, we have purchased 44.6 million shares for $779.6 million. See Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. The repurchase program is funded solely with domestic cash and, therefore, affects our overall domestic versus international liquidity balances.

      The following is a summary of our contractual obligations as of March 31, 2005:

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.

      Our revenues, 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 revenues, license bookings and/or earnings will have met expectations until shortly after the end of the quarter. Any significant shortfall in revenues, license bookings or earnings or lowered expectations could cause

our stock price to decline substantially. Factors that could affect our financial results include, but are not limited to:

      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.

      Our quarterly cash flow is and has been volatile. If our cash generated from operations in some future period is materially less than the market expects, our stock price 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 where revenues 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.

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

      In April 2005, we implemented a restructuring plan involving significant reductions in our workforce. Although we made efforts to minimize the impact on quota-carrying sales representatives, the workforce reductions included employees in our sales department, which could affect our ability to close future revenue transactions with our customers and prospects. The failure to retain and effectively manage our remaining employees could lead to decreased morale and attrition which could increase our costs, hinder our development efforts, impact the quality of our products, delay the delivery of new products or product updates and adversely affect our customer service. If we are unable to achieve the desired results of our restructuring plan, we could fall short of our profitability goals and could have to engage in additional restructuring activity. Further, we believe that our future success will depend in large part upon our ability to attract and retain highly skilled personnel. We could have difficulty attracting and retaining such personnel as a result of a perceived risk of future workforce reductions.

      Some of our largest competitors, including IBM, Computer Associates and HP, have significant scale advantages. With scale comes a large installed base of customers in particular market niches, as well as the ability to develop and market software competitive with ours. Some of these competitors can also bundle hardware, software, and services together, which is a disadvantage for us since we do not provide hardware and have far fewer services offerings. Competitive products are also offered by numerous independent software companies that specialize in specific aspects of the highly fragmented software industry. Some, like Microsoft, Oracle, and SAP, are the leading developers and vendors in their specialized markets. In addition, new companies enter the market on a frequent and regular basis, offering products that compete with those offered by us. As the software industry consolidates generally, it is possible that storage and security vendors such as EMC and Symantec will enter the systems management market. Additionally, many customers historically have developed their own products that compete with those offered by us. Competition from any of these sources can result in price reductions or displacement of our products, which could have a material adverse effect on our business, financial condition, operating results, and cash flow.

      The IT industry and the market for our systems management products is becoming increasingly competitive due to a variety of factors including a maturing enterprise infrastructure software market, changes in customer IT spending habits, and mixed economic recovery in the U.S. There is also a growing trend toward consolidation in the software industry. Continued consolidation within the software industry could create opportunities for larger software companies, such as IBM, Microsoft and Oracle, to increase their market

share through the acquisition of companies that dominate certain lucrative market niches or that have loyal installed customer bases. We expect this trend towards consolidation to continue as companies attempt to maintain or extend their market and competitive positions in the rapidly changing software industry and as companies are acquired or are unable to continue operations. This industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. This could lead to more variability in our operating results due to lengthening of the customer evaluation process and/or loss of business to these stronger competitors, which may materially and adversely affect our business, financial condition or results of operations.

      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. We have generally 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.

      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.

      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.

      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.

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 revenues.

      Growing market acceptance of open source software has presented both benefits and challenges to the commercial software industry in recent years. “Open source” software is made widely available by its authors and is licensed “as is” for a nominal fee or, in some cases, at no charge. We have incorporated some open source software into our products, allowing us to enhance certain solutions without incurring substantial additional research and development costs. Thus far, we have encountered no unanticipated material problems arising from our use of open source software. However, as the use of open source software becomes more widespread, certain open source technology could become competitive with our proprietary technology, which could cause sales of our products to decline or force us to reduce the fees we charge for our products, which could have a material adverse impact on our revenues and operating margins.

      If we fail to keep pace with technological change in our industry, such failure would have an adverse effect on our revenues. 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, the ability of our products to interoperate and perform well with existing and future leading databases and other platforms supported by our products and our ability to bring products to market that meet ever-changing customer requirements. To the extent that our current product portfolio does not meet such changing requirements, our revenues will suffer. 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.