BMC Software 10Q 2006 Q2 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)


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

For the quarterly period ended September 30, 2005


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

For the transition period from to

Commission file number 001-16393

BMC Software, Inc.

(Exact name of registrant as specified in its charter)


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

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

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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yesþ Noo

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

As of November 2, 2005, there were outstanding 216,297,538 shares of Common Stock, par value $.01, of the registrant.

BMC SOFTWARE, INC. AND SUBSIDIARIES
QUARTER ENDED SEPTEMBER 30, 2005

INDEX


		Page
PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets as of March 31, 2005 and September 30, 2005 (Unaudited)		3

	Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three months and six months ended September 30, 2004 and 2005 (Unaudited)		4

	Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2004 and 2005 (Unaudited)		5

	Notes to Condensed Consolidated Financial Statements (Unaudited)		6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operation		12

Item 3.	Quantitative and Qualitative Disclosures about Market Risk		33

Item 4.	Controls and Procedures		34

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings		35

Item 2.	Issuer Purchases of Equity Securities		36

Item 4.	Submission of Matters to a Vote of Security Holders		36

Item 6.	Exhibits		37

	Signatures		38
Certification of CEO pursuant to Section 13a-14(a)
Certification of CFO pursuant to Section 13a-14(a)
Certification of CEO pursuant to Section 13a-14(b)
Certification of CFO pursuant to Section 13a-14(b)

PART I. FINANCIAL INFORMATION

Item 1.Financial Statements

BMC SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In millions)


	March 31,			September 30,
	2005			2005
				(Unaudited)
ASSETS

Current assets:
Cash and cash equivalents	$	820.1		$	526.0
Marketable securities		108.7			341.3
Trade accounts receivable, net		191.8			110.6
Current trade finance receivables, net		151.8			118.1
Other current assets		168.0			171.1

Total current assets		1,440.4			1,267.1
Property and equipment, net		383.7			359.2
Software development costs and related assets, net		126.1			113.7
Long-term marketable securities		354.3			352.3
Long-term trade finance receivables, net		126.1			91.8
Acquired technology, net		65.9			39.5
Goodwill, net		559.7			559.0
Intangible assets, net		62.3			44.5
Other long-term assets		179.8			188.4

	$	3,298.3		$	3,015.5


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Trade accounts payable	$	37.3		$	27.0
Accrued liabilities		283.5			192.3
Current portion of deferred revenue		764.3			749.5

Total current liabilities		1,085.1			968.8
Long-term deferred revenue		868.0			810.0
Other long-term liabilities		83.4			82.2

Total liabilities		2,036.5			1,861.0
Commitments and contingencies		—			—
Stockholders’ equity:
Preferred stock		—			—
Common stock		2.5			2.5
Additional paid-in capital		571.7			576.5
Retained earnings		1,168.3			1,164.1
Accumulated other comprehensive income (loss)		(14.9	)		(17.1	)

		1,727.6			1,726.0
Less treasury stock, at cost		(459.3	)		(567.1	)
Less unearned portion of stock-based compensation		(6.5	)		(4.4	)

Total stockholders’ equity		1,261.8			1,154.5

	$	3,298.3		$	3,015.5

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

BMC SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)

(In millions, except per share data)

(Unaudited)


	Three Months Ended						Six Months Ended
	September 30,						September 30,
	2004			2005			2004			2005
Revenues:
License	$	132.5		$	117.2		$	232.8		$	231.1
Maintenance		199.9			221.5			404.7			435.1
Professional services		22.7			23.1			43.6			43.9

Total revenues		355.1			361.8			681.1			710.1

Operating Expenses:
Cost of license revenues		33.7			33.1			64.3			66.3
Cost of maintenance revenues		44.2			38.5			89.1			84.4
Cost of professional services		23.2			20.8			43.7			44.1
Selling and marketing expenses		131.2			116.4			255.9			260.5
Research and development expenses		55.4			54.4			102.6			113.1
General and administrative expenses		48.4			49.1			89.6			106.1
Settlement of litigation		11.3			—			11.3			—
Acquired research and development		0.2			—			0.2			—
Amortization of intangibles		5.3			9.2			9.5			18.2

Total operating expenses		352.9			321.5			666.2			692.7

Operating income		2.2			40.3			14.9			17.4
Other income, net		15.7			19.4			33.3			37.0

Earnings before income taxes		17.9			59.7			48.2			54.4
Income tax provision		5.2			16.9			24.8			52.7

Net earnings	$	12.7		$	42.8		$	23.4		$	1.7


Basic earnings per share	$	0.06		$	0.20		$	0.11		$	0.01

Diluted earnings per share	$	0.06		$	0.19		$	0.10		$	0.01

Shares used in computing basic earnings per share		222.6			217.6			222.8			218.4

Shares used in computing diluted earnings per share		223.9			220.8			224.5			220.7


Comprehensive income (loss):
Net earnings	$	12.7		$	42.8		$	23.4		$	1.7

Foreign currency translation adjustment		2.4			1.7			2.0			(3.3	)

Unrealized gain (loss) on securities available for sale:
Unrealized gain (loss), net of taxes of $0.6, ($1.0), ($3.4) and $0.2		1.1			(1.8	)		(6.4	)		0.3
Realized (gain) loss included in net earnings, net of taxes of ($0.1), ($0.1), $0.6 and ($0.4)		(0.2	)		(0.2	)		1.2			(0.7	)

		0.9			(2.0	)		(5.2	)		(0.4	)

Unrealized gain (loss) on derivative instruments:
Unrealized gain (loss), net of taxes of ($0.3), $0.1, ($0.3) and $0.8		(0.6	)		0.1			(0.6	)		1.5
Realized (gain) loss included in net earnings, net of taxes of $0.4, ($0.1), $0.5 and $0.1		0.8			(0.1	)		1.1			0.1

		0.2			—			0.5			1.6

Comprehensive income (loss)	$	16.2		$	42.5		$	20.7		$	(0.4	)

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

BMC SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

(Unaudited)


	Six Months Ended
	September 30,
	2004			2005
Cash flows from operating activities:
Net earnings	$	23.4		$	1.7

Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization		102.5			113.8
Acquired research and development		0.2			—
Provision (benefit) for uncollectible trade and finance receivables		(5.4	)		1.7
Impairment of investments		1.0			—
(Gain) loss on marketable securities		1.8			(1.1	)
Earned portion of stock-based compensation		1.4			1.8
Decrease in finance receivables		1.5			66.5
(Decrease) in payables to third-party financing institutions for finance receivables		(25.4	)		(14.0	)
(Decrease) in accrued exit costs		(17.0	)		(6.5	)
Net change in trade receivables, payables, deferred revenue and other components of working capital		16.1			(78.7	)

Net cash provided by operating activities		100.1			85.2


Cash flows from investing activities:
Cash paid for technology acquisitions and other investments, net of cash acquired		(212.0	)		(9.0	)
Return of capital for cost-basis investments		0.7			0.1
Proceeds from sale of financial instruments and other		4.5			—
Purchases of marketable securities		(119.5	)		(269.5	)
Proceeds from maturities / sales of marketable securities		191.0			39.6
Proceeds from sale of property and equipment		—			5.0
Purchases of property and equipment		(34.4	)		(11.8	)
Capitalization of software development costs and related assets		(29.6	)		(24.9	)

Net cash used in investing activities		(199.3	)		(270.5	)


Cash flows from financing activities:
Payments on capital leases		(2.3	)		(2.8	)
Stock options exercised and other		13.4			77.5
Treasury stock acquired		(45.0	)		(186.0	)

Net cash used in financing activities		(33.9	)		(111.3	)


Effect of exchange rate changes on cash		(0.2	)		2.5

Net change in cash and cash equivalents		(133.3	)		(294.1	)
Cash and cash equivalents, beginning of period		612.3			820.1

Cash and cash equivalents, end of period	$	479.0		$	526.0


Supplemental disclosure of cash flow information:
Cash paid for income taxes	$	10.1		$	37.5
Cash paid for interest	$	0.6		$	0.4

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

BMC SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) Basis of Presentation

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

These financial statements reflect all normal recurring adjustments, which, in the opinion of management, are necessary for a fair presentation of the results for the periods presented. These financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Certain amounts previously reported have been reclassified to provide comparability among the periods reported. Those reclassifications did not impact our net earnings or stockholders’ equity.

These financial statements should be read in conjunction with the Company’s audited financial statements for the year ended March 31, 2005, as filed with the Securities and Exchange Commission on Form 10-K.

(2) Earnings Per Share

Basic earnings per share (EPS) is computed by dividing net earnings by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. For purposes of this calculation, outstanding stock options and unearned restricted stock are considered potential common shares using the treasury stock method. For the three-month periods ended September 30, 2004 and 2005, the treasury stock method effect of 29.1 million and 9.2 million weighted options, respectively, has been excluded from the calculation of diluted EPS, as they are anti-dilutive. For the six-month periods ended September 30, 2004 and 2005, the treasury stock method effect of 24.4 million and 13.3 million weighted options, respectively, has been excluded from the calculation of diluted EPS, as they are anti-dilutive. The following table summarizes the basic and diluted EPS computations for the three months and six months ended September 30, 2004 and 2005, respectively:


	Three Months Ended				Six Months Ended
	September 30,				September 30,
	2004		2005		2004		2005
	(In millions, except per share data)
Basic earnings per share:
Net earnings	$	12.7	$	42.8	$	23.4	$	1.7
Weighted average number of common shares		222.6		217.6		222.8		218.4

Basic earnings per share	$	0.06	$	0.20	$	0.11	$	0.01


Diluted earnings per share:
Net earnings	$	12.7	$	42.8	$	23.4	$	1.7

Weighted average number of common shares		222.6		217.6		222.8		218.4
Incremental shares from assumed conversions of stock options and other		1.3		3.2		1.7		2.3

Adjusted weighted average number of common shares		223.9		220.8		224.5		220.7


Diluted earnings per share	$	0.06	$	0.19	$	0.10	$	0.01

(3) Business Combinations

On August 24, 2005, the Company acquired all of the outstanding capital stock of KMXperts Inc. The aggregate purchase price was $5.3 million in cash, including direct deal costs, and was allocated as follows: $2.5 million to acquired technology with a weighted average estimated life of three years, $0.6 million to customer relationships with a weighted average estimated life of three years, $1.9 million to goodwill, $0.1 million to a non-compete agreement to be amortized over a two year period and $0.2 million to tangible assets acquired, net of liabilities assumed.

KMXperts’ results have been included in the Company’s Condensed Consolidated Financial Statements since the acquisition date as part of the Service Management segment. KMXperts technology provides knowledge management solutions for IT service and customer support centers. The purchase agreement included a $1.5 million subsequent payment for post-acquisition services to be paid at the one-year anniversary of the purchase. This subsequent payment will be recorded as compensation expense over the twelve-month period of service, as it is based solely on continued employment with BMC.

4) Segment Reporting

Management reviews the results of the Company’s software business by the following product categories: Mainframe Management, including the Mainframe Data Management and MAINVIEW® product lines; Distributed Systems Management, which includes the PATROL®,Distributed Systems Data Management and Scheduling & Output Management product lines; Service Management; and Identity Management. In addition to these software segments, Professional Services is also considered a separate segment. The software segments above reflect management’s recategorization of certain products during fiscal 2006 to clarify accountability and increase organizational effectiveness. The amounts reported below for the three months and six months ended September 30, 2004 and 2005 reflect these changes in the composition of the Company’s business segments.

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


	Software
			Distributed
	Mainframe		Systems		Service		Identity		Professional
	Management		Management		Management		Management		Services			Consolidated
	(In millions)
Quarter Ended September 30, 2004
Revenues:
License	$	46.6	$	42.5	$	42.1	$	1.3	$	—		$	132.5
Maintenance		74.2		67.2		54.6		3.9		—			199.9
Professional services		—		—		—		—		22.7			22.7

Total revenues		120.8		109.7		96.7		5.2		22.7			355.1

Direct segment expenses		22.4		30.4		29.8		4.5		23.3			110.4


Segment contribution margin	$	98.4	$	79.3	$	66.9	$	0.7	$	(0.6	)		244.7


Indirect expenses													242.5
Other income, net													15.7

Earnings before income taxes												$	17.9


	Software
			Distributed
	Mainframe		Systems		Service		Identity		Professional
	Management		Management		Management		Management		Services		Consolidated
	(In millions)
Quarter Ended September 30, 2005
Revenues:
License	$	38.4	$	35.4	$	40.8	$	2.6	$	—	$	117.2
Maintenance		82.0		70.8		64.0		4.7		—		221.5
Professional services		—		—		—		—		23.1		23.1

Total revenues		120.4		106.2		104.8		7.3		23.1		361.8

Direct segment expenses		21.7		25.2		28.3		6.6		21.3		103.1


Segment contribution margin	$	98.7	$	81.0	$	76.5	$	0.7	$	1.8		258.7


Indirect expenses												218.4
Other income, net												19.4

Earnings before income taxes											$	59.7


	Software
			Distributed
	Mainframe		Systems		Service		Identity		Professional
	Management		Management		Management		Management		Services			Consolidated
	(In millions)
Six Months Ended September 30, 2004
Revenues:
License	$	82.2	$	75.5	$	72.4	$	2.7	$	—		$	232.8
Maintenance		152.8		137.7		106.7		7.5		—			404.7
Professional services		—		—		—		—		43.6			43.6

Total revenues		235.0		213.2		179.1		10.2		43.6			681.1

Direct segment expenses		44.8		60.1		52.5		9.0		43.7			210.1


Segment contribution margin	$	190.2	$	153.1	$	126.6	$	1.2	$	(0.1	)		471.0


Indirect expenses													456.1
Other income, net													33.3

Earnings before income taxes												$	48.2


	Software
			Distributed
	Mainframe		Systems		Service		Identity		Professional
	Management		Management		Management		Management		Services		Consolidated
					(In millions)
Six Months Ended September 30, 2005
Revenues:
License	$	78.8	$	72.0	$	75.7	$	4.6	$	—	$	231.1
Maintenance		161.2		139.5		125.3		9.1		—		435.1
Professional services		—		—		—		—		43.9		43.9

Total revenues		240.0		211.5		201.0		13.7		43.9		710.1

Direct segment expenses		42.5		50.1		57.0		12.4		41.4		203.4


Segment contribution margin	$	197.5	$	161.4	$	144.0	$	1.3	$	2.5		506.7


Indirect expenses												489.3
Other income, net												37.0

Earnings before income taxes											$	54.4

(5) Stock Incentive Plans

The Company has numerous stock plans that provide for the grant of common stock options and restricted stock to employees and directors of the Company. Under the option plans, all options issued during the three and six month periods ended September 30, 2004 and 2005 have been granted with exercise prices equal to the quoted market price on the date of grant and have a ten-year term. The restricted stock issued under the Company’s stock plans is subject to transfer restrictions that lapse over one to four years. The Company also has an employee stock purchase plan (ESPP) under which rights to purchase the Company’s common stock are granted at 85% of the lesser of the market value of the common stock at the offering date or on the exercise date.

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

For the three months ended September 30, 2004 and 2005, the Company recorded compensation expense of $0.3, and $0.1 million, respectively, for restricted stock grants. For the six months ended September 30, 2004 and 2005, the Company recorded compensation expense of $0.6 million and $0.4 million, respectively for restricted stock grants. The Company was not required to record compensation expense for stock option grants and stock issued under the ESPP during the same periods, except for unvested replacement options issued as consideration in the Company’s July 15, 2004 acquisition of Marimba, Inc. For the three months ended September 30, 2004 and 2005, the Company recorded compensation expense of $0.8 million and $0.7 million, respectively, related to the Marimba transaction replacement options. For the six months ended September 30, 2004 and 2005, the Company recorded compensation expense of $0.8 million and $1.3 million, respectively, related to the Marimba transaction replacement options.

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


		Three Months Ended						Six Months Ended
		September 30,						September 30,
		2004			2005			2004			2005
		(In millions, except per share data)
Net earnings	As Reported	$	12.7		$	42.8		$	23.4		$	1.7

Add stock-based employee compensation expense included in net earnings as reported of $1.1, $1.0, $1.4 and $1.8, net of related tax effects			0.7			0.7			0.9			1.2

Deduct stock-based employee compensation expense determined under the fair value-based method for all awards, net of related tax effects			(25.4	)		(10.4	)		(47.9	)		(19.8	)


	Pro Forma	$	(12.0	)	$	33.1		$	(23.6	)	$	(16.9	)


Basic earnings (loss) per share:	As Reported	$	0.06		$	0.20		$	0.11		$	0.01

	Pro Forma	$	(0.05	)	$	0.15		$	(0.11	)	$	(0.08	)


Diluted earnings (loss) per share:	As Reported	$	0.06		$	0.19		$	0.10		$	0.01

	Pro Forma	$	(0.05	)	$	0.15		$	(0.11	)	$	(0.08	)

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R), “Share-Based Payment,” which is a revision of SFAS No. 123. SFAS No. 123(R) supersedes APB Opinion No. 25 and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. SFAS No. 123(R) permits adoption using one of two methods: (1) a “modified prospective” method in which compensation cost is recognized beginning on the effective date based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and based on SFAS No. 123 for all awards granted to employees prior to the effective date that remain unvested on the effective date or (2) a “modified retrospective” method which includes the requirements of the modified prospective method, but also permits entities to restate all periods presented or prior interim periods of the year of adoption based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures. The Company plans to adopt SFAS No. 123(R) using the modified prospective method. In April 2005, the Securities and Exchange Commission 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. The Company will adopt SFAS No. 123(R) as of April 1, 2006, the beginning of the Company’s fiscal year ending March 31, 2007. The Company is currently assessing various valuation methods and will finalize its selection of a valuation method prior to adoption of SFAS No. 123(R).

As permitted by SFAS No. 123, we currently account for share-based payments to employees using the APB Opinion No. 25 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 the SFAS No. 123(R) 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 Company’s audited financial statements for the year ended March 31, 2005, as filed with the Securities and Exchange Commission on Form 10-K. 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.

(6) Exit Activities and Related Costs

During the year ended March 31, 2004, the Company implemented a plan (FY2004 Plan) that included the involuntary termination of approximately 785 employees during that year. The workforce reduction was across all functions and geographies and affected employees were provided cash separation packages. The Company also exited leases in certain locations, reduced the square footage required to operate some locations and relocated some operations to lower cost facilities. The relocation efforts for the FY2004 Plan were completed as of December 31, 2003.

As of September 30, 2005, $31.5 million of severance and facilities costs related to actions completed under the FY2004 Plan remained accrued for payment in future periods, as follows:


	Balance at							Effect of			Cash Payments,			Balance at
	March 31,				Adjustments			Exchange Rate			Net of Sublease			September 30,
	2005		Accretion		to Estimates			Changes			Income			2005
	(In millions)
Severance and related costs	$	1.1	$	—	$	(0.1	)	$	(0.1	)	$	(0.2	)	$	0.7
Facilities costs		40.1		0.8		(1.6	)		(0.1	)		(8.4	)		30.8


Total accrued	$	41.2	$	0.8	$	(1.7	)	$	(0.2	)	$	(8.6	)	$	31.5

The FY2004 Plan amounts accrued at September 30, 2005, related to facilities costs represent the remaining fair value of lease obligations for exited locations, as determined at the cease-use dates of those facilities, net of estimated sublease income that could be reasonably obtained in the future, and will be paid out over the remaining lease terms, the last of which ends in fiscal 2011. The Company does not expect any significant additional severance or facilities charges related to the FY2004 Plan subsequent to September 30, 2005 other than potential adjustments to lease accruals based on actual subleases differing from estimates. Accretion (the increase in the present value of facilities accruals over time) and adjustments to original estimates are included in operating expenses.

During the first quarter ended June 30, 2005, the Company implemented a plan (FY2006 Plan) that is expected to allow the Company to realize its profitability goals by reducing costs and realigning resources to focus on growth areas. The FY2006 Plan included the involuntary termination of 725 employees. The workforce reduction was across all functions and geographies and affected employees were provided cash separation packages. The workforce reduction has reduced selling and general and administrative expenses in product areas that are not realizing the Company’s profitability and growth goals. The Company does not expect any significant additional severance or facilities charges related to the FY2006 Plan subsequent to September 30, 2005 other than potential adjustments to lease accruals based on actual subleases differing from estimates. Accretion (the increase in the present value of facilities accruals over time) and adjustments to the original estimates are included in operating expenses. The net expense, with adjustments, for the quarter and six months ended September 30, 2005 related to the FY2006 plan are as follows:


	Three Months Ended September 30, 2005
	Adjustments to Estimates
	Severance &
	Related					Incremental
	Costs			Facilities		Depreciation		Total
	(In millions)
Cost of license revenues	$	—		$	—	$	—	$	—
Cost of maintenance revenues		—			—		—		—
Cost of professional services		(0.5	)		—		—		(0.5	)
Selling and marketing expenses		(0.2	)		—		—		(0.2	)
Research and development expenses		—			—		—		—
General and administrative expenses		—			—		—		—

Total included in operating expenses	$	(0.7	)	$	—	$	—	$	(0.7	)


	Six Months Ended September 30, 2005
	Severance
	& Related				Incremental
	Costs		Facilities		Depreciation		Total
	(In millions)
Cost of license revenues	$	1.3	$	—	$	—	$	1.3
Cost of maintenance revenues		3.0		—		—		3.0
Cost of professional services		2.7		—		—		2.7
Selling and marketing expenses		25.8		0.2		—		26.0
Research and development expenses		3.9		—		—		3.9
General and administrative expenses		5.2		0.3		0.8		6.3

Total included in operating expenses	$	41.9	$	0.5	$	0.8	$	43.2

As of September 30, 2005, $3.2 million of severance and facilities costs related to actions completed under the FY2006 Plan remained accrued for payment in future periods, as follows:


								Cash
	Balance at		Charged		Adjustments			Payments, Net			Balance at
	March 31, 2005		to Expense		to Estimates			of Sublease Income			September 30, 2005
	(In millions)
Severance and related costs	$	—	$	42.6	$	(0.7	)	$	(39.1	)	$	2.8
Facilities costs		—		0.5		—			(0.1	)		0.4


Total accrued	$	—	$	43.1	$	(0.7	)	$	(39.2	)	$	3.2

(7) Income Taxes

The income tax expense for the three months and six months ended September 30, 2004 was $5.2 million and $24.8 million, resulting in effective tax rates of 29% and 51%, respectively. The income tax expense for the three months and six months ended September 30, 2005 was $16.9 million and $52.7 million, resulting in effective tax rates of 28% and 97%, respectively.

The Company’s effective tax rate and associated provision for income taxes for the three months and six months ended September 30, 2004 and 2005 were based on our estimates of consolidated earnings before taxes for fiscal 2005 and 2006, respectively. The effective tax rate is impacted by the worldwide mix of estimated consolidated earnings before taxes, estimated tax credits, estimated tax incentives and our assessment regarding the realizability of the Company’s deferred tax assets. Included in income tax expense for the six months ended September 30, 2004, was a non-recurring accrual of approximately $11.1 million to adjust the Company’s 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 the Company’s income tax accounts in the first quarter of fiscal 2005. Excluding these items, the effective tax rate for the six months ended September 30, 2004 was 28%. Included in income tax expense for the six months ended September 30, 2005, is a tax provision of approximately $36.5 million related to the Company’s adoption of a plan to repatriate approximately $717.2 million of qualified earnings under the applicable provisions of the American Jobs Creation Act of 2004 (the Act), of which $550.0 million has been repatriated to date. The Act provides for a special one-time tax deduction of 85% of certain foreign earnings that are repatriated. Excluding this item, the effective tax rate for the six months ended September 30, 2005 was 30%.

(8) Guarantees

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

(9) Tradenames

Under the purchase accounting method for acquisitions, portions of the purchase prices for the Company’s acquisitions were allocated to other intangible assets, including tradenames. Through March 31, 2005, most of the Company’s acquired tradenames were not amortized because the assets were deemed to have indefinite remaining useful lives. As a result of a recently initiated re-branding campaign, the Company changed the estimated economic useful lives, effective April 1, 2005, of acquired tradenames from indefinite to between one and two years. The carrying amount of the previously unamortized tradenames at March 31, 2005 was $25.2 million and is being amortized on a straight-line basis over the remaining estimated useful life commencing April 1, 2005. The pre-tax increase in amortization expense for tradenames resulting from this change in estimate for the three months and six months ended September 30, 2005 was $3.3 million and $6.4 million, respectively. The after-tax effect of the increase in amortization expense for tradenames for the three months ended September 30, 2005 on net earnings of $2.6 million decreased basic and diluted earnings per share by $0.01. For the six months ended September 30, 2005, the after-tax effect of the increase in amortization expense for tradenames on net earnings of $5.0 million decreased basic and diluted earnings per share by $0.02.

(10) Subsequent Event

In November 2005, in light of depletion of the previous authorization, the Board of Directors authorized the Company to repurchase up to an additional $1.0 billion of its common stock.

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

This section of the Report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are identified by the use of the words “believe,” “expect,” “anticipate,” “will,” “contemplate,” “would” and similar expressions that contemplate future events. Numerous

important factors, risks and uncertainties affect our operating results, including, without limitation, those contained in this Report, and could cause our actual results to differ materially from the results implied by these or any other forward-looking statements made by us or on our behalf. There can be no assurance that future results will meet expectations. You should pay particular attention to the important risk factors and cautionary statements described in the section of this Report entitled “Certain Risks and Uncertainties.” It is important that the historical discussion below be read together with the attached condensed consolidated financial statements and notes thereto, with the discussion of such risks and uncertainties, with the audited financial statements and notes thereto, and with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for fiscal 2005.

Overview

BMC Software is one of the world’s largest independent software vendors. Delivering Business Service Management (BSM), 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.

For the quarter and six months ended September 30, 2005, our diluted earnings per share was $0.19 and $0.01 per share, respectively, as compared to diluted earnings per share of $0.06 and $0.10 per share, respectively for the same periods in the prior year. The increase in the quarterly diluted earnings per share is driven by higher revenues and lower operating expenses during the quarter ended September 30, 2005, as a result of our recent restructuring activities. The decrease in the diluted earnings per share for the six months ended September 30, 2005, compared to the six months ended September 30, 2004, is primarily due to the exit activity costs pertaining to the FY2006 Plan as described in note 6 herein and the tax provision for repatriated earnings as described in note 7 herein. The restructuring actions associated with the FY2006 Plan had a negative short-term impact on our license revenues. As part of the restructuring, we have redeployed our sales resources and are selling a more strategic type of solution to higher-level executives, frequently at the CIO level. This has resulted in a longer sales cycle and lower closure rates. However, we expect this change to ultimately improve our sales closure success. Our license revenues during the quarter ended September 30, 2005 were $117.2 million, as compared to $132.5 million for the quarter ended September 30, 2004. The decrease in license revenues is primarily attributed to lower license bookings during the second quarter. Our maintenance revenues during the quarter ended September 30, 2005 were $221.5 million, as compared to $199.9 million for the quarter ended September 30, 2004. Maintenance revenues increased primarily as a result of the additional revenue associated with acquired products and the continuing growth in the base of installed Service Management products. We maintained a strong balance sheet with cash and cash equivalents and marketable securities at September 30, 2005 of $1,219.6 million. Cash flows generated by operations for the six months ended September 30, 2005 were $85.2 million compared to $100.1 million in the same prior year period. During the second quarter of fiscal 2006, we spent approximately $100.0 million to repurchase approximately 4.9 million shares of our common stock.

Industry Conditions

The worldwide market for spending on IT solutions remains challenging. 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 for new customers and to maintain our relationships with our current customers. This competition can lead to sales pricing pressure and can affect our margins. We discuss competition in greater detail underCertain Risks and Uncertaintiesbelow.

Critical Accounting Policies

The preparation of condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we make and evaluate estimates and judgments, including those related to revenue recognition, capitalized software development costs, acquired technology, in-process research and development, goodwill and intangible assets, valuation of investments and accounting for income taxes. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances; the results of which form the basis for making judgments about amounts and timing of revenues and expenses, the carrying values of assets, and the recorded amounts of liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and such estimates may change if the underlying conditions or assumptions change. We have discussed the development and selection of the critical accounting policies with the Audit Committee of our Board of Directors, and the Audit Committee has reviewed our related disclosures. The critical accounting policies related to the estimates and judgments listed above are discussed further in our Annual Report on Form 10-K for fiscal 2005 under Management’s Discussion and Analysis of Financial Condition and Results of Operations. There have been no changes to our critical accounting policies during the six months ended September 30, 2005.

Certain amounts previously reported have been reclassified to provide comparability among the periods reported. Those reclassifications did not impact our net earnings or stockholders’ equity.

Results of Operations and Financial Condition

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


	Percentage of Total Revenues
	Three Months Ended						Six Months Ended
	September 30,						September 30,
	2004			2005			2004			2005
Revenues:
License		37.3	%		32.4	%		34.2	%		32.5	%
Maintenance		56.3			61.2			59.4			61.3
Professional services		6.4			6.4			6.4			6.2

Total revenues		100.0			100.0			100.0			100.0

Operating Expenses:
Cost of license revenues		9.5			9.1			9.4			9.3
Cost of maintenance revenues		12.4			10.6			13.1			11.9
Cost of professional services		6.5			5.7			6.4			6.2
Selling and marketing expenses		36.9			32.2			37.6			36.7
Research and development expenses		15.6			15.0			15.1			15.9
General and administrative expenses		13.6			13.6			13.2			14.9
Settlement of litigation		3.2			—			1.7			—
Acquired research and development		0.1			—			—			—
Amortization of intangibles		1.5			2.5			1.4			2.6

Total operating expenses		99.4			88.9			97.8			97.5

Operating income		0.6			11.1			2.2			2.5
Other income, net		4.4			5.4			4.9			5.2

Earnings before income taxes		5.0			16.5			7.1			7.7
Income tax provision		1.5			4.7			3.6			7.4

Net earnings		3.6	%		11.8	%		3.4	%		0.2	%

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.


	Three Months Ended						Six Months Ended
	September 30,						September 30,
	2004		2005		% Change		2004		2005		% Change
	(In millions)						(In millions)
License:
Domestic	$	61.6	$	62.4		1.3%	$	108.0	$	115.1		6.6%
International		70.9		54.8		(22.7)%		124.8		116.0		(7.1)%

Total license revenues		132.5		117.2		(11.5)%		232.8		231.1		(0.7)%


Maintenance:
Domestic		111.8		123.3		10.3%		226.8		243.2		7.2%
International		88.1		98.2		11.5%		177.9		191.9		7.9%

Total maintenance revenues		199.9		221.5		10.8%		404.7		435.1		7.5%


Professional services:
Domestic		10.2		9.1		(10.8)%		20.1		17.8		(11.4)%
International		12.5		14.0		12.0%		23.5		26.1		11.1%

Total professional services revenues		22.7		23.1		1.8%		43.6		43.9		0.7%

Total revenues	$	355.1	$	361.8		1.9%	$	681.1	$	710.1		4.3%

Product License Revenues

Our product license revenues primarily consist of fees related to products licensed to customers on a perpetual basis. Product license fees can be associated with a customer’s licensing of a given software product for the first time or with a customer’s purchase of the right to run a previously licensed product on additional computing capacity or for additional 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 revenues decreased 11.5% and 0.7% for the quarter and six months ended September 30, 2005, compared to the same periods last year. In addition to lower closure rates, customer procurement process slowdowns and weakness in IT spending resulted in the decline in license revenues for the second quarter and six-month periods of fiscal 2006. License bookings, which are defined as recognized license revenues plus the net change in deferred license revenues for the period and represents the license value of transactions completed in the period, decreased 26% and 10% for the quarter and six months ended September 30, 2005 compared to the prior year periods. License bookings for the quarter were less than expected due to delays in closing new deals. The number of license transactions over $1 million that closed during the quarter decreased to 12 from 19 in the prior year period. The total license value of these 12 transactions was $27.6 million, including amounts recognized and deferred, compared to $65.4 million for the 19 transactions in the comparable prior year period. For the second quarter, there were no transactions over $10 million.

For the quarter and six months ended September 30, 2004 and 2005, our recognized license revenues were impacted by the changes in our deferred license revenue balance as follows:


	Three Months Ended						Six Months Ended
	September 30,						September 30,
	2004			2005			2004			2005
	(In millions)
Deferrals of license revenue	$	(47.4	)	$	(38.3	)	$	(69.5	)	$	(71.2	)
Recognition from deferred license revenue		32.7			46.8			71.5			94.0

Net impact on recognized license revenues	$	(14.7	)	$	8.5		$	2.0		$	22.8


Deferred license revenue balance at end of quarter	$	350.3		$	384.4

The primary reasons for license revenue deferrals include customer transactions that contain certain complex contractual terms and conditions, customer transactions for products that have different maintenance pricing methodologies, such as arrangements which include the right to license both Remedy products and other BMC Software products, time-based licenses which are recognized over the term of the arrangement, customer transactions which include products with differing maintenance periods and other transactions for which we do not have or are not able to determine vendor-specific objective evidence of the fair value of the maintenance and/or professional services. All of these instances cause the license revenues to be deferred under the residual method of accounting for multiple element arrangements. 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 continue to 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 revenue for a particular contract must be deferred, based on the contractual terms and application of revenue recognition policies to those terms, we recognize such license revenue either ratably over the term of the contract or when the revenue recognition criteria are met. Because of this, we generally know the timing of the subsequent recognition of license revenue at the time of deferral. Therefore, the amount of license revenues to be recognized out of the deferred revenue balance in each future quarter is generally predictable, and our total license revenues to be recognized each quarter become more predictable as a larger percentage of those revenues come from the deferred license revenue balance. As of September 30, 2005, the deferred license revenue balance was $384.4 million and had an average remaining life of approximately three years. As additional license revenues are deferred in future periods, the amounts to be recognized in future periods will increase. A summary of the estimated deferred license revenues we expect to recognize in future periods as of September 30, 2005 are as follows:


	(In millions)
Remaining fiscal 2006	$	96.3
Fiscal 2007		137.2
Fiscal 2008 & thereafter		150.9

Our domestic operations generated 46.5% and 53.2% of license revenues for the quarters ended September 30 2004 and 2005, respectively. For the six month periods ended September 30, 2004 and 2005, domestic operations generated 46.4% and 49.8% of license revenues, respectively. Domestic license revenues for the quarter and six months ended September 30, 2005 increased 1.3% and 6.6%, respectively, compared to the comparable periods in the prior fiscal year primarily as a result of Mainframe revenue and Service Management revenue growth, primarily attributed to several large ratable transactions that closed in the second quarter of fiscal 2005. International license revenues represented 53.5% and 46.8% of license revenues for the quarters ended September 30, 2004 and 2005. For the six month periods ended September 30, 2004 and 2005, international revenues represented 53.6% and 50.2% of license revenues, respectively. International license revenues for the quarter and six months ended September 30, 2005 decreased 22.7% and 7.1%, respectively, compared to the same periods last year, primarily attributed to a 32.7% decrease in Mainframe and a 14.9% decrease in Distributed System revenues during the three months ended September 30, 2005. Foreign currency exchange rate changes, including the impact of hedging, resulted in a favorable impact to international license revenues of 0.3% and 0.8% for the quarter and six months ended September 30, 2005.

Maintenance, Enhancement and Support Revenues

Maintenance, enhancement and support revenues represent the ratable recognition of fees to enroll licensed products in our software maintenance, enhancement and support program. Maintenance, enhancement and support enrollment generally entitles customers to product enhancements, technical support services and ongoing compatibility with third-party operating systems, database management systems, networks, storage systems and applications. These fees are generally charged annually and are based on the discounted license list price for legacy BMC Software products and a percentage of the undiscounted license list price for Remedy and Magic products. Customers are generally entitled to reduced annual maintenance percentages for entering into long-term maintenance contracts that include prepayment of the maintenance fees or that are supported by a formal financing arrangement. 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 10.8% and 7.5% for the quarter and six months ended September 30, 2005, over the comparable prior year periods, 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 revenues can have quarterly fluctuations based on the timing of contracts, renewal rates and new license bookings. 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 for purchases with 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 lower growth rates for our maintenance revenues. As of September 30, 2005, the deferred maintenance revenue balance was $1,147.0. As additional maintenance revenues are deferred in future periods, the amounts to be recognized in future periods will increase. A summary of the estimated deferred maintenance revenues we expect to recognize in future periods as of September 30, 2005 are as follows:


	(In millions)
Remaining fiscal 2006	$	332.2
Fiscal 2007		410.6
Fiscal 2008 & thereafter		404.2

Product Line Revenues


	Three Months Ended						Six Months Ended
	September 30,						September 30,
	2004		2005		% Change		2004		2005		% Change
	(In millions)						(In millions)
Mainframe Management:
Mainframe Data Management	$	90.0	$	89.8		(0.2)%	$	175.6	$	180.8		3.0%
MAINVIEW		30.8		30.6		(0.6)%		59.4		59.2		(0.3)%

		120.8		120.4		(0.3)%		235.0		240.0		2.1%

Distributed Systems Management:
PATROL		55.2		57.4		4.0%		110.4		111.6		1.1%
Distributed Systems Data Management		20.5		15.0		(26.8)%		38.4		30.8		(19.8)%
Scheduling and Output Management		34.0		33.8		(0.6)%		64.4		69.1		7.3%

		109.7		106.2		(3.2)%		213.2		211.5		(0.8)%

Service Management		96.7		104.8		8.4%		179.1		201.0		12.2%
Identity Management		5.2		7.3		40.4%		10.2		13.7		34.3%


Total license and maintenance revenues	$	332.4	$	338.7		1.9%	$	637.5	$	666.2		4.5%

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

Mainframe Management revenues represented 35.5% and 36.0% of our total license and maintenance revenues for the quarter and six months ended September 30, 2005, compared to 36.3% and 36.9% for the quarter and six months ended September 30, 2004, respectively. Total license and maintenance revenues for Mainframe Management decreased 0.3% in the quarter compared to the prior year period due to delayed new license sales which are expected to close in the next quarter, offset by strong maintenance renewals for our base of installed customers. For the six months ended September 30, 2005, total revenue for this product line increased 2.1% compared to the same period in the prior year, primarily as a result of steady maintenance renewals.

Distributed Systems Management revenues represented 31.4% and 31.7% of our total license and maintenance revenues for the quarter and six months ended September 30, 2005, compared to 33.0% and 33.4% for the quarter and six months ended September 30, 2004, respectively. Total license and maintenance revenues for this group decreased 3.2% and 0.8% for the quarter and six months ended September 30, 2005 from the same period in the prior year, primarily as a result of new license sales not closing in the second quarter offset by steady maintenance renewals.

Service Management revenues represented 30.9% and 30.2% of our total software revenues for the quarter and six months ended September 30, 2005, compared to 29.1% and 28.1% for the quarter and six months ended September 30, 2004, respectively. Total software revenues for this group increased 8.4% and 12.2% for the quarter and six months ended September 30, 2005, from the same periods in the prior year. Year to date performance is driven by a 4.4% increase in license revenue coupled with a 17.4% increase in maintenance revenue.

Identity Management revenues represented 2.2% and 2.1% of our total software revenues for the quarter and six months ended September 30, 2005, respectively, compared to 1.6% for the quarter and six months ended September 30, 2004. Total software revenues for this group increased 40.4% and 34.3% for the quarter and six months ended September 30, 2005, from the same period in the prior year primarily as a result of our ability to offer a more comprehensive solution in the identity management market following the acquisitions of Calendra and OpenNetwork.

Professional Services Revenues

Professional services revenues, representing fees from implementation, integration and education services performed during the periods, increased 1.8% and 0.7% for the quarter and six months ended September 30, 2005, respectively, compared to the prior year periods. The decrease in domestic professional services revenue for the quarter and six months ended September 30, 2005 of 10.8% and 11.4%, respectively, is primarily attributable to a strategic shift to focus on large, leading edge BSM implementations and is partially offset by the increase in professional services internationally of 12.0% and 11.1%, respectively from the prior year comparable periods.

Operating Expenses

Operating expenses for the quarter and six months ended September 30, 2005 include exit activity costs pertaining to the FY2006 Plan as shown in the following table and described in note 6 herein.


	Three Months Ended							Six Months Ended
	September 30,							September 30,
	2004		2005		% Change			2004		2005		% Change
	(In millions)							(In millions)
Cost of license revenues	$	33.7	$	33.1		(1.8	)%	$	64.3	$	66.3		3.1	%
Cost of maintenance revenues		44.2		38.5		(12.9	)%		89.1		84.4		(5.3	)%
Cost of professional services		23.2		20.8		(10.3	)%		43.7		44.1		0.9	%
Selling and marketing expenses		131.2		116.4		(11.3	)%		255.9		260.5		1.8	%
Research and development expenses		55.4		54.4		(1.8	)%		102.6		113.1		10.2	%
General and administrative expenses		48.4		49.1		1.4	%		89.6		106.1		18.4	%
Settlement of litigation		11.3		—		—			11.3		—		—
Acquired research and development		0.2		—		—			0.2		—		—
Amortization of intangibles		5.3		9.2		73.6	%		9.5		18.2		91.6	%

Total operating expenses	$	352.9	$	321.5		(8.9	)%	$	666.2	$	692.7		4.0	%

Excluding the costs associated with the exit activities and related FY2006 plan costs, as described below, total operating expenses decreased 8.7% and 2.5%, for the three and six month periods ended September 30 2005, compared to the prior year periods. As a result of the restructuring, we are now recognizing significant cost savings and expect to continue to do so in future periods.

Exit Activities and Related Costs

As of September 30, 2005, $31.5 million of severance and facilities costs related to actions completed under the FY2004 Plan remained accrued for payment in future periods, as follows:


								Effect of			Cash Payments,
	Balance at				Adjustments			Exchange Rate			Net of Sublease			Balance at
	March 31, 2005		Accretion		to Estimates			Changes			Income			September 30, 2005
	(In millions)
Severance and related costs	$	1.1	$	—	$	(0.1	)	$	(0.1	)	$	(0.2	)	$	0.7
Facilities costs		40.1		0.8		(1.6	)		(0.1	)		(8.4	)		30.8


Total accrued	$	41.2	$	0.8	$	(1.7	)	$	(0.2	)	$	(8.6	)	$	31.5

The FY2004 Plan amounts accrued at September 30, 2005 related to facilities costs represent the remaining fair value of lease obligations for exited locations, as determined at the cease-use dates of those facilities, net of estimated sublease income that could be reasonably obtained in the future, and will be paid out over the remaining lease terms, the last of which ends in fiscal 2011. We do not expect any significant additional severance or facilities charges related to the FY2004 Plan subsequent to September 30, 2005 other than potential adjustments to lease accruals based on actual subleases differing from estimates. Accretion (the increase in the present value of facilities accruals over time) and adjustments to original estimates are included in operating expenses.

During the first quarter ended June 30, 2005, we implemented a plan (FY2006 Plan) that is expected to allow us to realize our profitability goals by reducing costs and realigning resources to focus on growth areas. The FY2006 Plan included the involuntary termination of 725 employees. The workforce reduction was across all functions and geographies and affected employees were provided cash separation packages. The workforce reduction has reduced selling and general and administrative expenses in product areas that are not realizing our profitability and growth goals. We do not expect any significant additional severance or facilities charges related to the FY2006 Plan subsequent to September 30, 2005 other than potential adjustments to lease accruals based on actual subleases differing from estimates. Accretion (the increase in the present value of facilities accruals over time) and adjustments to the original estimates are included in operating expenses. The net expense, with adjustments, for the quarter and six months ended September 30, 2005 related to the FY2006 plan are as follows:


	Three Months Ended September 30, 2005
	Adjustments to Estimates
	Severance
	& Related					Incremental
	Costs			Facilities		Depreciation		Total
	(In millions)
Cost of license revenues	$	—		$	—	$	—	$	—
Cost of maintenance revenues		—			—		—		—
Cost of professional services		(0.5	)		—		—		(0.5	)
Selling and marketing expenses		(0.2	)		—		—		(0.2	)
Research and development expenses		—			—		—		—
General and administrative expenses		—			—		—		—

Total included in operating expenses	$	(0.7	)	$	—	$	—	$	(0.7	)


	Six Months Ended September 30, 2005
	Severance
	& Related				Incremental
	Costs		Facilities		Depreciation		Total
	(In millions)
Cost of license revenues	$	1.3	$	—	$	—	$	1.3
Cost of maintenance revenues		3.0		—		—		3.0
Cost of professional services		2.7		—		—		2.7
Selling and marketing expenses		25.8		0.2		—		26.0
Research and development expenses		3.9		—		—		3.9
General and administrative expenses		5.2		0.3		0.8		6.3

Total included in operating expenses	$	41.9	$	0.5	$	0.8	$	43.2

As of September 30, 2005, $3.2 million of severance and facilities costs related to actions completed under the FY2006 Plan remained accrued for payment in future periods, as follows:


								Cash
	Balance at		Charged		Adjustments			Payments, Net			Balance at
	March 31, 2005		to Expense		to Estimates			of Sublease Income			September 30, 2005
	(In millions)
Severance and related costs	$	—	$	42.6	$	(0.7	)	$	(39.1	)	$	2.8
Facilities costs		—		0.5		—			(0.1	)		0.4


Total accrued	$	—	$	43.1	$	(0.7	)	$	(39.2	)	$	3.2

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.

Cost of License Revenues

Cost of license revenues is primarily comprised of (i) the amortization of capitalized software costs for internally developed products, (ii) amortization of purchased software included in internally developed products, (iii) amortization of acquired technology for products acquired through business combinations, (iv) license-based royalties to third parties, (v) production and distribution costs for initial product licenses, (vi) severance, and (vii) facilities costs related to personnel/locations that develop product licenses. For the quarters ended September 30, 2004 and 2005, the cost of license revenues represented 9.5% and 9.1% of total revenues, respectively and 25.4% and 28.2% of license revenues, respectively. For the six months ended September 30, 2004 and 2005, the cost of license revenues represented 9.4% and 9.3% of total revenues, respectively, and 27.6% and 28.7% of license revenues, respectively. The cost of license revenues decreased 1.8% for the quarter ended September 30, 2005, compared to the same period in the prior year, primarily as a result of headcount reductions incurred during fiscal 2006 relating to the FY2006 Plan as described inExit Activities and Related Costs.The cost of license revenues increased 3.1% for the six months ended September 30, 2005, primarily due to the amortization of acquired technology from the acquisition of Marimba and Viadyne in the second quarter of fiscal 2005, as compared to the year earlier periods.

As discussed in note 1(f) to our audited consolidated financial statements for the year ended March 31, 2005, contained in our annual report on Form 10-K, we capitalize software development costs in accordance with SFAS No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.” The following table summarizes the amounts capitalized and amortized during the quarter and six months ended September 30, 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.


	Three Months Ended						Six Months Ended
	September 30,						September 30,
	2004			2005			2004			2005
	(In millions)
Software development and purchased software costs capitalized	$	(15.4	)	$	(13.8	)	$	(29.6	)	$	(24.9	)
Total amortization		18.1			18.6			37.5			36.6

Net impact on operating expenses	$	2.7		$	4.8		$	7.9		$	11.7


Accelerated amortization included in total amortization above	$	0.4		$	0.2		$	1.2		$	0.3

Cost of Maintenance Revenues

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. For the quarters ended September 30, 2004 and 2005, the cost of maintenance revenues represented 12.4% and 10.6% of total revenues, respectively and 22.1% and 17.4% of maintenance revenues, respectively. For the six months ended September 30, 2004 and 2005, the cost of maintenance revenues represented 13.1% and 11.9% of total revenues, respectively and 22.0% and 19.4% of maintenance revenues, respectively. The cost of maintenance revenues decreased 12.9% and 5.3% for the quarter and six months ended September 30, 2005, respectively, primarily as a result of decreased personnel costs relating to the FY2006 Plan as described inExit Activities and Related Costs,as compared to the year earlier periods.

Cost of Professional Services

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. For the quarters ended September 30, 2004 and 2005, the cost of professional services revenues represented 6.5% and 5.7% of total revenues, respectively and 102.2% and 90.0% of professional services revenues, respectively. For the six months ended September 30, 2004 and 2005, the cost of professional services revenues represented 6.4% and 6.2% of total revenues, respectively and 100.2% and 100.5% of professional services revenues, respectively. The cost of professional services revenues decreased 10.3% in the quarter ended September 30, 2005 compared to the quarter ended September 30, 2004, primarily as a result of decreased personnel costs relating to the FY2006 Plan as described inExit Activities and Related Costs,as compared to the year earlier periods. The cost of professional services revenues increased 0.9% for the six months ended September 30, 2005, as compared to the six months ended September 30, 2004, primarily as a result of severance costs under the FY2006 Plan as described inExit Activities and Related Costsabove.

Selling and Marketing

Our selling and marketing expenses primarily include personnel and related costs, sales commissions and costs associated with advertising, industry trade shows and sales seminars. For the quarters ended September 30, 2004 and 2005, selling and marketing costs represented 36.9% and 32.2% of total revenues, respectively and decreased 11.3% from the year earlier period. This decrease is attributed to the FY2006 Plan described inExit Activities and Related Costs.For the six months ended September 30, 2004 and 2005, selling and marketing expenses represented 37.6% and 36.7% total revenues, respectively and increased 1.8% from the year earlier period. This increase is primarily due to severance costs incurred early in fiscal 2006 relating to the FY2006 Plan. For the quarters and six months ended September 30, 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:


	Three Months Ended				Six Months Ended
	September 30,				September 30,
	2004		2005		2004		2005
	(In millions)
Net impact of change in deferred commissions on selling and marketing expenses	$	6.9	$	4.8	$	5.7	$	10.9


Total deferred commissions balance	$	8.3	$	47.9	$	8.3	$	47.9

Research and Development

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 data processing center. Research, development and support expenses represented 15.6% and 15.0% of total revenues for the quarters ended September 30, 2004 and 2005, respectively. Research, development and support expenses decreased 1.8% in the quarter ended September 30, 2005, as compared to the quarter ended September 30, 2004, primarily as the result of a decrease in personnel costs relating to the FY2006 Plan as described inExit Activities and Related Costs.For the six months ended September 30, 2004 and 2005, research, development and support expenses represented 15.1% and 15.9% of total revenues, respectively, and increased 10.2% from the year earlier period, primarily as a result of severance costs incurred early in fiscal 2006 relating to the FY2006 Plan.

General and Administrative

General and administrative expenses are comprised primarily of compensation and personnel costs within executive management, finance and accounting, IT, facilities management, legal and human resources. Other costs included in general and administrative expenses are fees paid for outside legal and accounting services, consulting projects, insurance and severance pertaining to exit activities and related costs. General and administrative expenses represented 13.6% of total revenues in the quarters ended September 30, 2004 and 2005, and 13.2% and 14.9% for the six months ended September 30, 2004 and 2005, respectively. These expenses increased 1.4% and 18.4% for the quarter and six months ended September 30, 2005, compared to the same periods in the prior year. The increase is primarily due to higher professional fees, consisting of legal, accounting and consulting fees associated with our Sarbanes-Oxley Section 404 compliance efforts. For the six months ended September 30, 2005 compared to the same period in the prior year, we incurred approximately $10 million of additional third party fees associated with our initial year Sarbanes Oxley compliance efforts.

Amortization of Intangibles

Under the purchase accounting method for acquisitions, portions of the purchase prices for our acquisitions were allocated to other intangible assets, including tradenames. Through March 31, 2005, most of our acquired tradenames were not amortized because the assets were deemed to have indefinite remaining useful lives. However, as a result of a recently initiated re-branding campaign, we changed the estimated economic useful lives, effective April 1, 2005, of acquired tradenames from indefinite to between one and two years. The carrying amount of the previously unamortized tradenames at March 31, 2005 was $25.2 million and is being amortized on a straight-line basis over a two-year period commencing April 1, 2005. For the quarter ended September 30, 2005, the pre-tax increase in amortization expense resulting from this change in estimate was $3.3 million. For the quarter ended September 30, 2005, the amortization of intangibles had a $2.6 million after tax effect on net earnings and decreased basic and diluted earnings per share by $0.01. For the six months ended September 30, 2005, the pre-tax increase in amortization expense resulting from this change in estimate was $6.4 million. The after-tax effect of the increase in amortization expense for tradenames

for the six months ended September 30, 2005 on net earnings of $5.0 million decreased basic and diluted earnings per share by $0.02. For the quarter ended September 30, 2004, amortization of intangibles was $5.3 million, as compared to $9.2 million for the quarter ended September 30, 2005. For the six months ended September 30, 2004, amortization of intangibles was $9.5 million, as compared to $18.2 million for the six months ended September 30, 2005.

Other Income, Net

Other income, net consists primarily of interest earned on cash, cash equivalents, marketable securities and finance receivables, rental income on owned facilities and gains and losses on marketable securities and other investments. For the quarter and six months ended September 30, 2005, other income, net, was $19.4 million and $37.0 million, respectively, reflecting an increase of $3.7 million from each of the same periods the prior year. The increase is primarily due to additional interest income generated from investment portfolio balances due to an increase in interest rates.

Income Taxes

Our effective tax rate and associated provision for income taxes for the three months and six months ended September 30, 2004 and 2005 were based on our estimates of consolidated earnings before taxes for fiscal 2005 and 2006, respectively. The effective tax rate is impacted by the worldwide mix of estimated consolidated earnings before taxes, estimated tax credits, estimated tax incentives and our assessment regarding the realizability of our deferred tax assets. Included in income tax expense for the six months ended September 30, 2004, was a non-recurring accrual of approximately $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. Excluding these items, the effective tax rate for the six months ended September 30, 2004 was 28%. Included in income tax expense for the six months ended September 30, 2005, is a tax provision of approximately $36.5 million related to our adoption of a plan to repatriate approximately $717.2 million of qualified earnings under the applicable provisions of the American Jobs Creation Act of 2004, of which $550.0 million has been repatriated to date. The Act provides for a special one-time tax deduction of 85% of certain foreign earnings that are repatriated. Excluding this item, the effective tax rate for the six months ended September 30, 2005 was 30%.

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. In July 2005, the FASB decided not to provide additional guidance on the meaning of other-than-temporary impairment and issued proposed FSP EITF 03-1-a, “Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1,” as final (the FASB retitled this FSP as FSP FAS 115-1 and 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” and posted the FSP on November 3, 2005). The final FSP supersedes EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The final FSP replaces the guidance set forth in paragraphs 10 through 18 of EITF Issue 03-1 with references to existing other-than-temporary impairment guidance, such as SFAS No. 115.FSP FAS 115-1 and 124-1 clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell has not been made. FSP FAS 115-1 and 124-1 shall be applied to reporting periods beginning after December 15, 2005. We do not expect the new guidance to have a material effect on our 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. SFAS No. 123(R) supersedes APB Opinion No. 25 and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. Pro forma disclosure is no longer an alternative. SFAS No. 123(R) permits adoption using one of two methods: (1) a “modified

prospective” method in which compensation cost is recognized beginning on the effective date based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and based on SFAS No. 123 for all awards granted to employees prior to the effective date that remain unvested on the effective date or (2) a “modified retrospective” method which includes the requirements of the modified prospective method, but also permits entities to restate all periods presented or prior interim periods of the year of adoption based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures. The Company plans to adopt SFAS No. 123(R) using the modified prospective method. In April 2005, the Securities and Exchange Commission 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. The Company will adopt SFAS No. 123(R) as of April 1, 2006, the beginning of our fiscal year ending March 31, 2007. We are currently evaluating the impact of SFAS No. 123(R) on our financial position and 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 financial position or results of operations.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections — a replacement of APB No. 20 and FAS 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. This Statement shall be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. This Statement does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of this Statement.

Liquidity and Capital Resources

The financial data utilized in analyzing our liquidity and financial position is summarized in the tables below:


	Six Months Ended
	September 30,
	2004		2005
	(In millions)
Cash flow data:
Cash provided by operating activities	$	100.1	$	85.2
Treasury stock acquired		45.0		186.0
Cash paid for technology acquisitions and other investments, net of cash acquired		212.0		9.0


	March 31,		September 30,
	2005		2005
	(In millions)
Balance sheet data:
Cash and cash equivalents and marketable securities	$	1,283.1	$	1,219.6
Trade accounts receivable, net (including current finance receivables)		343.6		228.7
Long-term trade finance receivables, net		126.1		91.8
Deferred revenue		1,632.3		1,559.5

Operating Activities

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


	Six Months Ended
	September 30,
	2004			2005
	(In millions)
Net earnings	$	23.4		$	1.7
Adjustments to net earnings for items whose cash effects are investing or financing cash flows		106.9			114.5
Decrease in finance receivables		1.5			66.5
(Decrease) in payables to third-party financing institutions for finance receivables		(25.4	)		(14.0	)
(Decrease) increase in accrued exit costs		(17.0	)		(6.5	)
All other, net		10.7			(77.0	)

Net cash provided by operating activities	$	100.1		$	85.2

•

The most significant component of adjustments to net earnings for items whose cash effects are investing or financing cash flows is depreciation and amortization, as follows:


	Six Months Ended
	September 30,
	2004		2005
	(In millions)
Depreciation	$	27.8	$	30.5
Amortization of capitalized software development costs		37.9		36.6
Amortization of acquired technology		26.0		28.6
Amortization of intangible assets		9.5		18.2
Amortization of premiums (discounts) on marketable debt securities		1.3		(0.1	)

Depreciation and amortization	$	102.5	$	113.8

For the six months ended September 30, 2005, the increase in adjustments to net earnings for items whose cash effects are investing or financing cash flows is primarily due to the increase in amortization for the period. The increase in amortization of intangible assets is a result of a recently initiated re-branding campaign, whereby we changed the estimated economic useful lives, effective April 1, 2005, of our acquired tradenames from indefinite to between one and two years, and are reporting the change prospectively as a change in estimate. See discussion inAmortization of Intangiblesabove.


	•		For the six months ended September 30, 2005, the decrease in finance receivables is primarily due to cash collections.

	•		The primary component of all other, net cash used in operating activities is the decrease in deferred revenues.

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

Investing Activities

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


	Six Months Ended
	September 30,
	2004			2005
	(In millions)
Cash paid for technology acquisitions and other investments, net of cash acquired	$	(212.0	)	$	(9.0	)
Proceeds from maturities / sales of marketable securities		191.0			39.6
Purchases of property and equipment		(34.4	)		(11.8	)
Purchases of marketable securities		(119.5	)		(269.5	)
All other, net		(24.4	)		(19.8	)

Net cash used in investing activities	$	(199.3	)	$	(270.5	)

•

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

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

	•		The primary use of cash in investing activities is from the purchases of marketable securities.

Financing Activities

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


	Six Months Ended
	September 30,
	2004			2005
	(In millions)
Treasury stock acquired	$	(45.0	)	$	(186.0	)
Payments on capital leases		(2.3	)		(2.8	)
Stock options exercised and other		13.4			77.5

Net cash used in financing activities	$	(33.9	)	$	(111.3	)

	•		There were no borrowings during the six months ended September 30, 2004 and 2005, and the main use of cash for financing activities was the acquisition of treasury stock. During the six months ended September 30, 2005, approximately 9.9 million shares of treasury stock were purchased, representing a significant increase over previous quarters. We plan to continue this increased pace of treasury stock purchases, subject to market conditions, other possible uses of our cash and our domestic liquidity position.

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

The Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2004 and 2005 are included in the accompanying condensed consolidated financial statements.

Cash and Cash Equivalents and Marketable Securities

At September 30, 2005, our cash and cash equivalents and marketable securities were $1,219.6 million, a decrease of approximately $63.5 million from March 31, 2005. This decrease is primarily the result of treasury stock purchases, partially offset by cash flow generated from operating activities and proceeds from the exercise of stock options for the six months ended September 30, 2005. Approximately 47% of the cash and cash equivalents and marketable securities at September 30, 2005 is held in international locations and was largely generated from our international operations. Our international operations have generated approximately $96.7 million of earnings for which United States income taxes have not been recorded. We have incurred tax expense of approximately $36.5 million related to our adoption of a plan to repatriate approximately $717.2 million of qualified international earnings under the applicable provisions of the American Jobs Creation Act of 2004, of which $550.0 million has been repatriated to date. The Act provides for a special one-time tax deduction of 85% of certain foreign earnings that are repatriated. SeeIncome Taxesabove for additional discussion.

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.

Treasury Stock Purchases

As of September 30, 2005, our Board of Directors had 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 the quarter and six months ended September 30, 2005, we purchased approximately 4.9 million and 9.9 million shares for $100.0 million and $186.0 million, respectively. From the inception of the repurchase program through September 30, 2005, we have purchased 54.5 million shares for $965.6 million. SeePART II. Item 2. Issuer Purchases of Equity Securitiesbelow for a monthly detail of treasury stock purchases for the quarter ending September 30, 2005. The repurchase program is funded solely with domestic cash and marketable securities and, therefore, affects the domestic versus international liquidity balances.

In November 2005, in light of depletion of the previous authorization, the Board of Directors authorized us to repurchase up to an additional $1.0 billion of our common stock. Such purchases will occur over time through open market purchases, through unsolicited or solicited privately negotiated transactions, or in such other manner as will comply with the provisions of the Securities Exchange Act of 1934 and the rules and regulations thereunder.

Contractual Obligations

Our contractual obligations are disclosed in our Annual Report on Form 10-K for the year ended March 31, 2005. There have been no material changes to our contractual obligations since March 31, 2005.

Acquisitions

On August 24, 2005, we acquired all of the outstanding capital stock of KMXperts Inc., for an aggregate purchase price of $5.3 million in cash, including direct deal costs. KMXperts’ results have been included in our Condensed Consolidated Financial Statements since the acquisition date as part of the Service Management segment. This acquisition will strengthen our BSM-related offerings through the addition of knowledge management solutions for IT service and customer support centers.

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 and are by no means listed in terms of their importance or level of risk to the company.

We may announce lower than expected revenues, license bookings or earnings, which could cause our stock price to decline.

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:

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

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

	•		the possibility that the negotiated terms and conditions of transactions may result in a different mix of license and maintenance revenues on an aggregate basis than is expected based on historical results and financial planning;

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

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

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

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

	•		higher than expected operating expenses;

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

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

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

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

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 (including the increase in 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 revenue could decline.

Maintenance revenues have increased in each of the last three fiscal years as a result of acquisitions and the continuing growth in the base of installed products and the processing capacity on which they run. Maintenance fees increase as the processing capacity on which the products are installed increases; consequently, we receive higher absolute maintenance fees with new license and maintenance agreements and as existing customers install our products on additional processing capacity. Due to increased discounting for higher levels of additional processing capacity, the maintenance fees on a per unit of capacity basis are typically reduced in enterprise license agreements. In addition, customers 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.

Our restructuring may not achieve our desired results and, if unsuccessful, could adversely affect our business.

In April 2005, we implemented a restructuring plan, the 2006 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.

The software industry includes large, powerful multi-line and small, agile single-line competitors.

Some of our largest competitors, including International Business Machines Corp (IBM), Computer Associates International, Inc. (Computer Associates) and Hewlett-Packard Company (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 Corporation (Microsoft), Oracle Corporation (Oracle), and SAP Aktiengesellschaft (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 Corporation (EMC) and Symantec Corporation (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 flows.

Industry consolidation could affect prices or demand for our products.

The IT industry and the market for our systems management products are 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 United States. 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.

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

IBM, HP, Microsoft and Oracle are by far the largest suppliers of systems and database software and, in many cases, are the manufacturers of the computer hardware systems used by most of our customers. Historically, operating and database system developers have modified or introduced new operating systems, database systems, systems software and computer hardware. Such new products could incorporate features which perform functions currently performed by our products or could require substantial modification of our products to maintain compatibility with these companies’ hardware or software. 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.

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

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

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

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

Future product development is dependent upon access to and reliability of third-party software products.

Certain of our software products contain components developed and maintained by third-party software vendors. We expect that we may have to incorporate software from third-party vendors in our future products. 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 could cause a decline in our revenues and operating margins.

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.

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

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.

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

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

our risk further because in the event of a system-wide failure, it may be difficult to determine which product is at fault; thus, we may be harmed by the failure of another supplier’s products. As a result of the foregoing, we could experience:

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

	•		loss of customers;

	•		damage to our reputation;

	•		failure to achieve market acceptance;

	•		diversion of development resources;

	•		increased service and warranty costs;

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

	•		increased insurance costs.

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

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

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

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

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

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

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

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

Our customers may not accept our product strategies.

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

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

We update our compensation plans for the sales organization periodically. As in most years, we have made significant changes for fiscal 2006. These plans are intended to align with our business objectives of providing customer flexibility and satisfaction. The compensation plans may encourage behavior not anticipated or intended as it is implemented, which could adversely affect our business, financial condition, operating results and/or cash flows. Changes to our sales compensation plan could also make it difficult for us to attract and retain top sales talent.

Risks related to business combinations.

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

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

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

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

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

Enforcement of our intellectual property rights.

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

Possibility of infringement claims.

From time to time, we receive notices from third parties claiming infringement by our products of patent and other intellectual property rights. We expect that software products will increasingly be subject to such claims as the number of products and competitors in our industry segments grows and the functionality of products overlaps. In addition, we may receive more patent infringement claims as companies increasingly seek to patent their software and business methods and enforce such patents, especially given the increase in software and business method patents issued during the past several years. Regardless of its merit, responding to

any such claim could be time-consuming, result in costly litigation and require us to enter into royalty and licensing agreements, which may not be offered or available on terms acceptable to us. If a successful claim is made against us and we fail to develop or license a substitute technology, our business, financial condition or operating results could be materially adversely affected.

Risks related to global operations.

We are a global company with research and development sites in the United States, Israel, Belgium, France and India, and sales offices around the world. As a result, we face risks from operating as a global concern, including, among others:

	•		difficulties in staffing and managing international operations;

	•		possible non-compliance with our professional conduct policy and code of ethics due to inconsistent interpretations and/or application of corporate standards;

	•		longer payment cycles;

	•		increased financial accounting and reporting burdens and complexities;

	•		adverse tax consequences;

	•		changes in currency exchange rates;

	•		potential impact from volatile or sluggish local economies;

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

	•		the need to localize our products;

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

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

	•		licenses, tariffs and other trade barriers.

We maintain a significant presence in India, conducting software development and support and IT operations. To date, the dispute between India and Pakistan involving the Kashmir region has not adversely affected our operations in India. Should we be unable to conduct operations in India in the future, we believe that our business could be temporarily adversely affected. As the software and technology labor market in India has developed at a rapid pace, with many multi-national companies competing for talent, there is a risk that wage and attrition rates will rise faster than we have anticipated, which could lead to operational issues.

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

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

We have identified material weaknesses in our disclosure controls and procedures and our internal control over financial reporting, which, if not remedied effectively, could have an adverse effect on our business.

Management, through documentation, testing and assessment of our internal control over financial reporting pursuant to the rules promulgated by the Securities and Exchange Commission under Section 404 of the Sarbanes-Oxley Act of 2002 and Item 308 of Regulation S-K, has concluded that our disclosure controls and procedures and our internal control over financial reporting had material weaknesses as of March 31, 2005. In response to these material weaknesses in our internal control over financial reporting, we are implementing, and may be required to further implement, additional controls and procedures. In addition, in response to these material weaknesses, we will have to hire additional personnel, possibly requiring significant time and expense. Furthermore, we intend to continue improving our internal control over financial reporting, and the implementation and testing of these continued improvements could result in increased cost and could divert management attention away from operating our business.

In future periods, if the process required by Section 404 of the Sarbanes-Oxley Act reveals further material weaknesses or significant deficiencies, the correction of any such material weakness or significant deficiency could require additional remedial measures which could be costly and time-consuming. If a material weakness exists as of a future period year-end (including a material weakness identified prior to year-end for which there is an insufficient period of time to evaluate and confirm the effectiveness of the corrections or related new procedures), our management will be unable to report favorably as of such future period year-end to the effectiveness of our control over financial reporting. If we are unable to assert that our internal control over financial reporting is effective in any future period, or if we continue to experience material weaknesses in our internal control over financial reporting, we could lose investor confidence in the accuracy and completeness of our financial reports, which would have an adverse effect on our stock price and potentially subject us to litigation.

If the carrying value of our long-lived assets were not recoverable, recognition of an impairment loss would be required, which would adversely affect our financial results.

We evaluate our long-lived assets, including property and equipment, goodwill, acquired product rights and other intangible assets, whenever events or circumstances occur which indicate that these assets might be impaired. In addition, the realizability of acquired technology and capitalized software development costs is evaluated quarterly, and goodwill and intangible assets with indefinite lives are evaluated annually for impairment in the fourth quarter of each fiscal year, regardless of events and circumstances. The reader should be aware that in the continuing process of evaluating the recoverability of the carrying amount of our long-lived assets, there is the possibility that we could identify a substantial impairment, which could adversely affect our financial results.

Revised accounting pronouncements related to share-based payments will reduce our reported earnings and could adversely affect our ability to attract and retain key personnel by reducing the share-based payments we are able to provide.

We use stock options and other long-term equity incentives as a fundamental component of our employee compensation packages. We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-term stockholder value and, through the use of vesting, encourage employees to remain with the Company. In accounting for our stock option grants using the intrinsic value method under the provisions of APB Opinion No. 25, we generally recognize no compensation cost because the exercise price of options granted is generally equal to the market value of our common stock on the date of grant. The FASB has revised United States generally accepted accounting principles such that we will be required to record charges to earnings for employee stock option grants, which will negatively impact our earnings. The impact cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. In addition, the New York Stock Exchange rule requiring stockholder approval for all stock option plans could make it more difficult for us to adopt plans to grant options to employees in the future. To the extent that it becomes more difficult or costly to grant options and/or other stock-based compensation to employees, we may incur increased cash compensation costs or find it difficult to attract, retain and motivate employees, either of which could materially adversely affect our business.

Interpretations of existing accounting pronouncements could adversely affect our financial results.

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

ITEM 3.Quantitative and Qualitative Disclosures about Market Risk

We are exposed to a variety of risks, including foreign currency exchange rate fluctuations and changes in the market value of our

investments in marketable securities. In the normal course of business, we employ established policies and procedures to manage these risks including the use of derivative instruments. There have been no material changes in our foreign exchange risk management strategy or our portfolio management strategy subsequent to March 31, 2005, therefore the risk profile of our market risk sensitive instruments remains substantially unchanged from the description in our Annual Report on Form 10-K for the year ended March 31, 2005.

ITEM 4.Controls and Procedures

Material Weaknesses Previously Disclosed

As discussed in Item 9A of our 2005 Annual Report on Form 10-K, we did not maintain effective internal control over financial reporting due to material weaknesses as of March 31, 2005 in the following three areas: (1) the design and operation of our internal controls over monitoring and analysis of vendor specific objective evidence (“VSOE”) of fair value of our maintenance and professional services; (2) the design and operation of our internal controls over monitoring and analysis of our deferred revenue account; and (3) the design and operation of our internal controls over the accounting for sales commissions. As also disclosed in our 2005 Annual Report, we are implementing actions to remediate these material weaknesses. While we have made progress in remediating the material weaknesses, we are continuing to address the issues underlying each of the material weaknesses, including both the process deficiencies and inadequate staffing of experienced, specialized accounting personnel. Sufficient time has not passed to properly test the effectiveness of the controls post-remediation.

Evaluation of Disclosure Controls and Procedures

As of September 30, 2005, we carried out an evaluation, under the supervision of our principal executive officer (CEO) and principal financial officer (CFO), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. In light of the material weaknesses previously disclosed, which have not been completely remediated as of the end of the period covered by this Quarterly Report, our CEO and CFO concluded, after the evaluation described above, that our disclosure controls were not effective, as of the end of the period covered by this Quarterly Report. Notwithstanding this conclusion, our preparation of the financial statements for the period covered by this report, and our evaluation of disclosure controls as of the end of such period, were conducted with particular attention to the material weaknesses previously disclosed, and management continued to retain third party consultants and hire additional accounting personnel during the period to provide certain compensating controls and other assistance in areas where material weaknesses were identified. Accordingly, management believes that the condensed consolidated financial statements included in this Quarterly Report fairly present, in all material respects our financial condition, results of operations and cash flows as of and for the periods presented.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting, except for the activities described below, all of which began in the fourth quarter of fiscal 2005 and continued into the second quarter of fiscal 2006.

We are undertaking efforts to remediate the material weaknesses identified above. Each of the identified material weaknesses was caused, in part, by inadequate staffing of experienced, specialized accounting personnel. Therefore, our remediation plans for each material weakness include hiring additional personnel trained and experienced in the complex accounting areas of revenue recognition, revenue accounting and sales commissions accounting. The remediation plans also include the following actions:

To provide reasonable assurance that we maintain proper VSOE of our maintenance and professional services, we:


	•		added preventive controls, including policies requiring executive level oversight of contract pricing;

	•		are increasing the communication between accounting and sales personnel and are increasing the training of our sales force regarding our revenue recognition rules;

	•		are increasing our review of maintenance and professional services contracts at the time of order entry; and

	•		are increasing the monitoring by our accounting department of the independent sales and renewal rates of our maintenance and professional services.

To provide reasonable assurance that we properly monitor and analyze our deferred revenue and accurately recognize such revenue, the revenue accounting department is:

	•		adding detailed transactional processes to analyze deferred contracts and properly recognize associated revenues;

	•		improving the monitoring of deferred contracts where recognition is dependent on the occurrence of one or more events; and

	•		conducting quarterly account analyses of deferred revenue.

To provide reasonable assurance that we properly account for sales commissions, the accounting department:

	•		added detailed transactional processes to analyze sales commissions and revenues recognized on associated transactions;

	•		is accounting for sales commissions on a detailed transactional basis;

	•		is applying consistent sales commission accounting policies in each region; and

	•		is reviewing the accounting for sales commissions quarterly.

During the second quarter of Fiscal 2006, our then Chief Financial Officer resigned. We named Stephen Solcher, a vice president, as interim finance chief.

We are actively recruiting to fill open positions in our accounting department, but the market for experienced accountants, particularly for software revenue recognition and revenue accounting experts, is highly competitive. This, combined with the heavy workload of the post-Sarbanes-Oxley regulatory environment, has made it difficult for us to recruit, hire and retain accounting talent. While there can be no assurance that we will be successful on a timely basis, we believe that we should be able to adequately staff the accounting function now that our initial assessment of our internal control over financial reporting as required by Sarbanes-Oxley Section 404 is completed. We expect it to take us until calendar year end, however, to complete the recruiting and hiring of the additional staff. We will continue to assess the adequacy of our accounting structure and organization, both in terms of size and United States generally accepted accounting principles expertise.

We believe that the actions described above and resulting improvement in controls will generally strengthen our disclosure controls and procedures, as well as our internal control over financial reporting, and will, over time, address the material weaknesses that we identified in our internal control over financial reporting as of March 31, 2005. However, because many of the remedial actions we have undertaken are very recent and because they relate, in part, to the hiring of additional personnel and many of the controls in our system of internal controls rely extensively on manual review and approval, the successful operation of these controls for, at least, several fiscal quarters may be required prior to management being able to conclude that the material weaknesses have been eliminated.

PART II. OTHER INFORMATION

ITEM 1.Legal Proceedings

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 United States 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 United States patent held by us. Discovery is in the early stages, and a final hearing in the case is not expected before calendar year 2006.

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

ITEM 2.Issuer Purchases of Equity Securities


					(c) Total Number
					of Shares		(d) Approximate
	(a) Total				Purchased as Part		Dollar Value of
	Number of		(b) Average		of Publicly		Shares that May Yet
	Shared		Price Paid		Announced		Be Purchased Under
Period	Purchased⁽¹⁾		per Share⁽¹⁾		Program⁽²⁾		the Program⁽²⁾
July 1-31, 2005		7,959	$	19.09		–	$	134,395,317
August 1-31, 2005		2,136,000	$	20.27		2,136,000	$	91,101,816
September 1-30, 2005		2,780,445	$	20.40		2,777,800	$	34,443,666
Total		4,924,404	$	20.30		4,913,800	$	34,443,666


1		Includes repurchases made pursuant to the publicly announced plan in footnote 2 below and repurchases in satisfaction of tax obligations upon the lapse of restrictions on employee restricted stock grants and repurchases of shares from Directors.

2		In April 2000, our Board of Directors authorized a $500.0 million stock repurchase program. In July 2002, the Board of Directors increased the authorized stock repurchase program by $500.0 million. At September 30, 2005, there was approximately $34.4 million remaining in the stock repurchase program. In November 2005, our Board of Directors authorized the addition of another $1 billion to the stock repurchase program. This program does not have an expiration date.

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

At BMC Software’s Annual Meeting of Stockholders held on August 23, 2005, the following proposals were adopted by the margins indicated.


	NUMBER OF SHARES
	VOTED FOR		WITHHELD
1. To elect nine directors of the Company, each to serve until the next annual meeting or until his/her respective successor has been duly elected and qualified.
B. Garland Cupp		181,943,288		18,390,100
Robert E. Beauchamp		181,995,316		18,338,072
Jon E. Barfield		184,492,368		15,841,020
John W. Barter		181,962,857		18,370,531
Meldon K. Gafner		171,032,298		29,301,090
Lew W. Gray		172,189,964		28,143,424
P. Thomas Jenkins		177,293,120		23,040,268
Louis J. Lavigne, Jr.		184,466,990		15,866,398
Kathleen A. O’Neil		184,593,137		15,740,251
George F. Raymond		181,893,071		18,440,317
Tom C. Tinsley		174,898,209		25,435,179

NUMBER OF SHARES

VOTED FOR

WITHHELD

ABSTAIN

2. To ratify the Board of Directors appointment of Ernst & Young LLP as the Company’s independent auditors for the year ending March 31, 2006.

198,806,999

394,052

1,132,336

NUMBER OF SHARES

VOTED FOR

WITHHELD

ABSTAIN

3. To approve an amendment to the BMC Software, Inc. 1994 Employee Incentive Plan (“the Incentive Plan”) to provide for the continuation of BMC Software’s historical practice of compensating its nonemployee directors with stock options by permitting them to be eligible for awards under the Incentive Plan and to extend the term which awards may be issued under the Incentive Plan.

120,127,359

56,627,795

1,224,759

ITEM 6.Exhibits

(a) Exhibits.

31.1

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

31.2

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

32.1

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

32.2

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

SIGNATURES

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


BMC SOFTWARE, INC.	By:	/s/ Robert E. Beauchamp

		Robert E. Beauchamp
November 9, 2005		President and Chief Executive Officer

	By:	/s/ Stephen B. Solcher

		Stephen B. Solcher
November 9, 2005		Chief Financial Officer

EXHIBIT INDEX

31.1

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

31.2

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

32.1

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

32.2

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

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman Avg

BMC Software Inactive 10-Q2006 Q2 Quarterly report

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