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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number 001-16393

BMC Software, Inc.

2101 CityWest Boulevard

77042-2827

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

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:     None

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

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

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

          The aggregate market value of the registrant’s voting stock held by non-affiliates of the registrant, based upon the last reported sale price of the registrant’s common stock on September 30, 2003 was $3,143,419,534.

          As of June 7, 2004, there were outstanding 222,814,853 shares of common stock, par value $.01, of the registrant.

DOCUMENTS INCORPORATED BY REFERENCE

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

          Definitive Proxy Statement filed in connection with the registrant’s Annual Meeting of Stockholders currently scheduled to be held on August 24, 2004 (Part III of this Report).

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

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PART I

Overview

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

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

Strategy

      Our strategy is focused on Business Service Management (BSM), the direct linkage of IT resources, management and solutions with the goals of the overall business. The objective of our BSM strategy is to enable companies to move beyond traditional IT management and manage their business-critical services from both an IT and business perspective. The intent of the BSM strategy is to provide solutions that will enable customers to link their IT resources tightly to business objectives and manage these resources based on business priorities by providing a “whole view” of their business and IT operations. Three important components of BSM are: 1) IT Operations and Infrastructure Management, 2) IT Service and Applications Management and 3) Service Impact Management.

      The IT Operations and Infrastructure Management component of the BSM strategy is based upon our historical strength in providing enterprise management solutions for data, infrastructure, application, performance and service management. We provide our customers with the ability to monitor and control the key components in their IT infrastructure, including systems, databases, applications, storage and networks, enabling them to tie service-level agreements to business needs, rather than technology metrics.

      We added an important element to our portfolio when we completed our acquisition of Remedy® in November 2002. Integration of Remedy’s industry-leading service desk, change management and asset management capabilities with our broad application and component management solutions enables us to deliver end-to-end, closed-loop service management to customers. Together, these solutions build a solid foundation for the IT Service and Applications Management component of the BSM strategy by offering both the delivery and support components of service management designed to be proactive, effective and focused on customer business requirements.

      An important component of BSM is to directly link business services to the underlying technology. The acquisition of IT Masters in March 2003 enables us to deliver the Service Impact Management component of the BSM strategy and enhances our competitive position in the service management market. IT Masters’ MasterCell® technology, renamed PATROL® for Service Impact Management, combines powerful event automation and service modeling capabilities to transform availability and performance data into detailed knowledge about the status of business services and service level agreements. Our comprehensive enterprise and service management solutions, combined with PATROL for Service Impact Management’s IT service

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      In late April 2004, we announced the signing of a definitive merger agreement with Marimba, Inc. (Marimba). The proposed acquisition is subject to customary closing conditions, including the approval of Marimba’s stockholders, and we anticipate closing this transaction during the second fiscal quarter of 2005. Once the transaction closes, we expect the Marimba products will strengthen our BSM technology by adding change and configuration management components.

      Our BSM strategy gained momentum in the market during fiscal 2004. This is evidenced by both our strong partnerships with industry leading companies and the feedback we are getting from our customers in terms of signed transactions. We identified over 100 transactions that were related to BSM in fiscal 2004. We also are experiencing increasing interest for BSM from customers as evidenced by a growing pipeline for our BSM business.

      Although we believe that we have the most complete BSM offering in the market today, our BSM strategy will continue to evolve over the next several years. In addition to adding new solutions, through both internal development and acquisitions, that support this strategy, we expect that our partnerships with leading companies will be a key factor in our BSM strategy. Our current BSM partnerships include Accenture, Dell, EMC, Siebel Systems, and Symantec.

Products

      Our software products are designed to help our customers proactively and automatically manage their businesses through our comprehensive enterprise management solutions. These solutions span enterprise systems, applications, databases and service management. During fiscal 2004, we managed our business along the following broad categories: Enterprise Data Management, Enterprise Systems Management, Remedy and Security and Other Solutions. For financial information related to these product categories, see Note 10 to the accompanying Consolidated Financial Statements.

      Our Enterprise Data Management solutions provide intelligent, automated data management tools across all major databases, including IBM’s IMS and DB2 for the mainframe environment and Microsoft’s SQL Server, IBM’s DB2 UDB and Informix databases and databases from Oracle and Sybase for distributed computing environments. This segment includes our SmartDBA family of database management tools, which offer highly automated monitoring and diagnostics, automation of day-to-day management tasks, and fast, reliable database backup and recovery. These solutions assist customers in lowering their operating costs and increasing their IT staff productivity by optimizing database availability as well as ensuring faster rollout of business applications. The software products in this segment address the following data management needs of businesses: application performance, database performance, space management, SQL development, SQL tuning, system performance, database administration, high-speed utilities and backup and recovery across mainframe and distributed computing environments. Our Enterprise Data Management solutions contributed approximately 45%, 44% and 37% of our license revenues in fiscal 2002, 2003 and 2004, respectively.

      Our Enterprise Systems Management solutions provide software tools for businesses to proactively and centrally manage their IT infrastructure. A solid infrastructure connected by a reliable network is the foundation of any successful business. It is vital to know that a problem exists before it impacts critical business applications. Accurate infrastructure management ensures that all components required to deliver quality service to users are under control and performing at optimal levels. Our solutions in this segment include our PATROL product line for distributed computing environments, our MAINVIEW® product line for mainframe computing environments and our enterprise job scheduling and output management solutions. Within this product group, we provide the following systems management solutions: server management for Unix, Windows, Linux and mainframe environments, applications management, network management,

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      Our Remedy software solutions enable organizations to automate and manage internal and external service and support processes. Remedy delivers out-of-the-box applications that help customers align service and support with business objectives, improve service levels, manage assets and lower costs. All Remedy applications, including the help desk, asset management, change management, service level agreement and customer support applications, are built on the highly flexible Action Request System®, empowering customers to easily adapt their Service Management solution to unique and changing requirements. On February 2, 2004, we acquired the assets of Magic Solutions (Magic) from Network Associates. Our Magic products provide IT Service support, including asset tracking, change management, and help desk products for small and medium size businesses. The Magic business is part of our Remedy business unit. Our Remedy software solutions contributed approximately 6% of our license revenues in the four months after acquisition in fiscal 2003 and contributed 19% of our license revenues for the twelve months, including the results from Magic in the two months post-acquisition, in fiscal 2004.

      Our Security and Other software solutions facilitate user registration and password administration and, thereby, enhance and strengthen the overall security of our customers’ information systems. This product line contributed approximately 4%, 3% and 2% of our license revenues in fiscal 2002, 2003 and 2004, respectively.

Sales and Marketing

      We market and sell our products in most major world markets directly through our sales force and indirectly through channel partners, including resellers, distributors and systems integrators. Our sales force includes an expanding inside sales division which provides us a lower-cost channel for additional sales into existing customers and expands our customer base. In addition, we market certain of our products online through our webstore located at http://www.bmc.com.

International Operations

      Approximately 42%, 44% and 46% of our total revenues in fiscal 2002, 2003 and 2004, respectively, were derived from business outside North America. For additional financial information regarding our North America and international operations, see “Management’s Discussion and Analysis of Results of Operations and Financial Condition — Revenues” and Note 10 to the accompanying Consolidated Financial Statements. Our international operations primarily provide sales, sales support, product support, marketing and product distribution services for our customers located outside of North America. We also conduct development activities in Tel Aviv, Israel for our scheduling, security, output management and ERP products, in France for our network management products and in Belgium for our service modeling products. Our development operations in Singapore provide local language support, product internationalization and integration with local-market hardware and software, and our development operations in China, Japan and Korea provide product localization and internationalization. As an extension of our primary development offices, our operations in Pune, India and Tel Hai, Israel provide internal IT support, new product development, maintenance and quality assurance for certain products. Also, our acquisition of ASA Knowledge Pty Ltd (ASA) in January 2004 has given us a small development operation in Australia. As a global company, we plan to continue to look for opportunities to efficiently expand our operations in international locations that offer highly talented resources as a way to maximize our global competitiveness. For a discussion of various unusual risks associated with our global operations and investments, see “Management’s Discussion and Analysis of Results of Operations and Financial Condition — Certain Risks and Uncertainties — Risks related to global operations.”

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      Our growth prospects are highly dependent upon the continued growth of our international software license and maintenance revenues, and such revenues have been somewhat unpredictable in the past. Revenues from our foreign subsidiaries are denominated in local currencies, as are operating expenses incurred in these locales. To date, we have not had any material foreign currency exchange gains or losses. For a discussion of our currency hedging program and the impact of currency fluctuations on international license revenues in fiscal 2003 and 2004, see “Management’s Discussion and Analysis of Results of Operations and Financial Condition — Product License Revenues” and Note 1(g) to the accompanying Consolidated Financial Statements. We have not previously experienced any difficulties in exporting our products, but no assurances can be given that such difficulties will not occur in the future.

Maintenance, Enhancement and Support Services

      Revenues from providing maintenance, enhancement and support services, or post contract support (“PCS”), comprised 45%, 48% and 53% of our total revenues in fiscal 2002, 2003 and 2004, respectively. Payment of maintenance, enhancement and support fees generally entitles a customer to telephone and Internet support and problem resolution services, including proactive notification, electronic support requests and a resolution database, and enhanced versions of products released during the maintenance period, including new versions necessary to run with the most current release of the operating systems, databases and other software supported by the products. Such maintenance fees are an important source of recurring revenue to us, and we invest significant resources in providing maintenance services and new product versions. Customers renew maintenance fees because they require forward compatibility and enhanced product features when they install new versions of the software systems supported by one of our products. These services are also important to our customers, who require immediate problem resolution, because they use our products to manage their business-critical IT systems.

Professional Services

      Our professional services group consists of a worldwide team of experienced software consultants who provide implementation, integration and education services related to our products. By easing the implementation of our products, these services help our customers accelerate the time to value. By improving the overall customer experience, these services also drive future software license transactions with these customers. Professional services contributed approximately 7%, 6% and 6% of our revenues for fiscal 2002, 2003 and 2004, respectively.

Product Pricing and Licensing

      Our software solutions are licensed under multiple license types using a variety of business metrics. We have historically licensed our software primarily on a perpetual basis; however, we also license customers the right to use our software for a defined period of time, referred to as a term contract. When a customer enters into a term contract, the contract will consist of a combined license and maintenance component for the length of the term. Some of our more common licensing models are as follows:

	•	Enterprise license — a license to use one or more products across a customer’s enterprise, usually subject to capacity limits. Capacity can be measured in many ways, including mainframe computing capacity, number of servers, number of users, or number of gigabytes, among others. Additional license fee, or upgrade, prices are specified in the enterprise license and are typically paid on an annual basis if a customer exceeds their capacity.
	•	Non-Enterprise license — a license to use one or more products up to a specific license capacity. An upgrade fee is due at the time the license capacity is exceeded.

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

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

Research, Development and Support

      In fiscal 2002, 2003 and 2004, research, development and support expenses, net of capitalized amounts, represented 39%, 37% and 41% of our total revenues, respectively. These costs related primarily to the compensation of research and development personnel and the costs associated with the maintenance, enhancement and support of our products. Although we develop many of our products internally, we may acquire technology from third parties when appropriate and may incur royalty and other payment obligations in connection with such acquisitions. Traditionally, we have acquired rights from third parties to use certain technologies that we believed would accelerate development of new products. Our expenditures on research and development and on product maintenance, enhancement and support, including amounts capitalized, in the last three fiscal years are discussed below under the heading, “Management’s Discussion and Analysis of Results of Operations and Financial Condition — Research, Development and Support.”

      We conduct research and development activities in Houston and Austin, Texas, Waltham, Massachusetts, Sunnyvale, California, Israel, India, France and Belgium, as well as in small offices in other locations around the world. Product manufacturing and distribution for the Americas are based in Houston, Texas, and Pleasanton, California, with European manufacturing and distribution based in Dublin, Ireland, and Asia Pacific manufacturing and distribution based in Singapore.

Seasonality

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

Competition

      The enterprise management software business is highly competitive, as discussed below and in the “Management’s Discussion and Analysis of Results of Operations and Financial Condition” section of this report under the heading “Certain Risks and Uncertainties.” There are several companies, including IBM, Computer Associates and Microsoft, as well as large computer manufacturers such as Sun Microsystems and Hewlett Packard, which have substantially greater resources than we have, as well as the ability to develop and market enterprise management solutions similar to and competitive with the solutions offered by us. In addition, there are numerous independent software companies that compete with one or more of our software solutions. Although we believe we are uniquely positioned to offer BSM solutions to customers, several of our major competitors have begun to market BSM-like solutions, and we anticipate continued competition in the BSM marketplace. Although no company competes with us across our entire software solution line, we consider at least 70 firms to be directly competitive with one or more of our enterprise software solutions. Certain of these companies have substantially larger operations than ours in these specific niches. In addition, the software industry is experiencing continued consolidation.

      Certain of our solutions in the Enterprise Data Management product group compete directly with IBM, primarily with IBM’s IMS and DB2 database management systems, and its IMS/TM and CICS transaction managers. Some of our solutions, including our core IMS and DB2 database tools and utilities, are essentially improved versions of system software utilities that are provided as part of these integrated IBM system software products. IBM also markets separately priced competing utilities in addition to its base utilities. IBM continues, directly and through third parties, to enhance and market its utilities for IMS and DB2 as lower cost alternatives to the solutions provided by us and other independent software vendors. Although such

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

Customers

      No single customer accounted for a material portion of our revenues during any of the past three fiscal years. Our software products are generally used in a broad range of industries, businesses and applications. Our customers include manufacturers, telecommunications companies, financial service providers, educational institutions, retailers, distributors, hospitals, service providers, government agencies and value-added resellers.

Intellectual Property

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

Employees

      As of March 31, 2004, we had 6,429 full-time employees. We believe that our continued success will depend in part on our ability to attract and retain highly skilled technical, sales, marketing and management personnel.

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      Our headquarters and principal marketing and product development operations are located in Houston, Texas, where we own four office buildings totaling approximately 1,515,000 square feet, of which we occupy approximately 67%. We lease the majority of the remaining space to third parties. We also maintain development and sales organizations in various locations around the world where we lease the necessary facilities. A summary of our principal leased properties that are currently in use is as follows:

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

      On July 31, 2001, Nastel Technologies, Inc. (Nastel) filed a complaint in arbitration alleging breach of a licensing agreement by us, copyright infringement, and theft of trade secrets. We filed a counterclaim again Nastel for reimbursement of overpaid royalties based upon conflicting licensing agreements. We believe we have meritorious defenses for the claims asserted against us. The parties have completed the arbitration hearing and are currently preparing post-hearing briefing. A ruling in this matter is expected in the second fiscal quarter of 2005.

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

      Not Applicable.

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PART II

      Our common stock is listed on the New York Stock Exchange and trades under the symbol BMC. On June 1, 2004 there were 1,333 holders of record of our common stock.

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

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

Issuer Purchases of Equity Securities

(1)	In April 2000, our Board of Directors authorized a $500 million stock repurchase program. In July 2002, the Board of Directors increased the authorized stock repurchase program by $500 million. At the end of fiscal 2004, there was approximately $307 million remaining in the stock repurchase program. This program does not have an expiration date.

      Information regarding our equity compensation plans as of March 31, 2004 is incorporated by reference into Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

Item 6.                         Selected Financial Data

      The following selected consolidated financial data presented under the captions “Statement of Operations Data” and “Balance Sheet Data” for, and as of the end of, each of the years in the five-year period ended

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      Prior to April 1, 2002, we were amortizing our acquired goodwill and intangible assets over three to five-year periods, which reflected the estimated useful lives of the respective assets. As of April 1, 2002, we adopted Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets.” In accordance with this Statement, goodwill and those intangible assets with indefinite lives are no longer amortized but, rather, are tested for impairment annually and when we believe an event or circumstance has occurred to reduce the fair value of one of these assets below its carrying value. If and when such impairment occurs, the asset is written down to its fair value. Note 5 to the accompanying Consolidated Financial Statements includes a reconciliation of our reported net earnings (loss) and earnings (loss) per share for the year ended March 31, 2002 to those amounts that would have resulted had there been no amortization of goodwill and intangible assets with indefinite lives for those periods. Note 5 to the accompanying Consolidated Financial Statements also discusses impairment charges recorded during the year ended March 31, 2002 related to goodwill and acquired technology, which materially impacted the results for that year.

      The Consolidated Financial Statements for fiscal 2000 and fiscal 2001 have been audited by Arthur Andersen LLP, independent public accountants. The Consolidated Financial Statements for fiscal 2002 through fiscal 2004 have been audited by Ernst & Young LLP, an independent registered public accounting firm. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements as of March 31, 2003 and 2004, and for each of the three years in the period ended March 31, 2004, the accompanying notes and the reports of the independent registered public accounting firms thereon, which are included elsewhere in this Form 10-K.

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Introduction

      We begin Management’s Discussion and Analysis of Results of Operations and Financial Condition (MD&A) with an overview to give the reader management’s perspective on BMC’s results for fiscal 2004 and our general outlook for the current fiscal year. This is followed by a discussion of the critical accounting policies that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results. This discussion is followed by a review of our recent, significant acquisitions. In the next section, we discuss our Results of Operations for fiscal 2003 compared to fiscal 2002 and for fiscal 2004 compared to fiscal 2003. We then provide an analysis of our liquidity and capital resources.

      This MD&A should be read in conjunction with the other sections of this Annual Report on Form 10-K, including “Item 1: Business”; “Item 6: Selected Financial Data”; and the accompanying Consolidated Financial Statements and notes thereto. The various sections of MD&A contain a number of forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this filing and particularly in the “Certain Risks and Uncertainties” section. Our actual results may differ materially from the results indicated by any forward-looking statements.

Overview

      In response to a challenging first quarter of fiscal 2004, we implemented a restructuring plan to better align our cost structure with existing market conditions. As a result of cost savings, additional license and contractual offerings and improved overall economic conditions, our business began to improve in the second half of fiscal 2004. In the middle of the year, we encouraged our sales force to make it clear to our customers that we offer multiple license models and will be flexible with our customers in how to structure their license arrangement. As a result of this increased emphasis on meeting the customers’ needs and the resultant flexibility, we have seen a significant increase in the number of transactions, which require deferral of the license fees and recognition of such fees ratably over the term of the contract as compared to previous years. Given the record amount of deferred revenue that we experienced during our third quarter, we introduced a new metric called license bookings that reflects the amount of new license contracts signed during a given quarter. License bookings can be calculated from our financial statements by simply summing current period license revenue plus net change to deferred license revenue, both calculated according to U.S. generally accepted accounting principles (GAAP). In both the third and fourth fiscal quarters of 2004, we saw significant year-over-year increases in license bookings. We attribute this growth in license bookings, in part, to our BSM strategy. Throughout the year, BSM has helped us open new accounts, increase new license bookings and close multiple large transactions. As we look ahead to fiscal 2005, we are planning for growth in license bookings and significant improvement in overall operating profit margins.

      Another important metric for us is our cash flows from operations, which were $498.7 million for fiscal 2004. While we continue to expect to generate significant cash flows from operations, we are not expecting the same levels of cash flows in fiscal 2005 for a variety of reasons, primarily that the amount of financed

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      In addition to internal development, we continue to look for strategic opportunities to extend our BSM strategy. To this end, we remained acquisitive during fiscal 2004 purchasing the assets of Magic from Network Associates.

      Finally, it is important for our investors to understand that a significant portion of our operating expenses is fixed in the short-term and we plan our expense run-rate based on our expectations of future revenue. If we have a shortfall in revenue in any given quarter, there is an immediate, sometimes significant, effect on our overall earnings.

Industry Conditions

      We believe that buyers of systems management software are now more focused on linking their IT operations and infrastructure with their overall business services. Although technology spending has been depressed over the past few years, there are multiple signs that enterprises around the world are making long-term and strategic commitments to systems management software, particularly with large vendors similar to BMC.

      While we remain optimistic about our business prospects and continue to believe that we are uniquely positioned to be the leading provider of BSM solutions, we recognize that the systems management software marketplace is highly competitive. We compete with a variety of software vendors, including large vendors such as IBM, HP, Computer Associates and a number of smaller software vendors. We compete for new customers and, from time to time, must compete to maintain our relationship with our current customers. This competition can lead to pricing pressure and can affect our margins. We discuss competition in greater detail in the “Certain Risks and Uncertainties” section of MD&A.

Critical Accounting Policies

      The preparation of consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Our accounting and financial reporting policies are in conformity with accounting principles generally accepted in the U.S. On an on-going basis, we make and evaluate estimates and judgments, including those related to revenue recognition, capitalized software development costs, valuation of investments and accounting for income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about amounts and timing of revenues and expenses, the carrying values of assets and the recorded amounts of liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and such estimates may change if the underlying conditions or assumptions change. We have discussed the development and selection of the critical accounting policies, communicated below, with the Audit Committee of our Board of Directors, and the Audit Committee has reviewed our related disclosures below.

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

      We recognize software license fees upon meeting all of the following four criteria: execution of the signed contract, delivery of the underlying products to the customer and the acceptance of such products by the customer, determination that the software license fees are fixed or determinable, and determination that

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