(1) Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of BMC Software, Inc. and its subsidiaries (collectively, we, us, our or BMC). All significant intercompany balances and transactions have been eliminated in consolidation. These financial statements reflect all normal recurring adjustments necessary to fairly present our financial position and results of operations as of and for the periods presented herein. We have evaluated subsequent events through October 30, 2009, the date the financial statements were issued. These financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (SEC). Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations.

Interim results are not necessarily indicative of results for a full year. Our results generally tend to be stronger in the third and fourth quarters of our fiscal year, as compared to the first and second quarters of our fiscal year. These financial statements should be read in conjunction with our annual audited consolidated financial statements for the fiscal year ended March 31, 2009, as filed with the SEC on Form 10-K.

Recently Adopted Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (FASB) issued a new accounting standard which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. In February 2008, the FASB delayed the effective date of this standard to April 1, 2009 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (that is, at least annually). We adopted the new standard relating to assets and liabilities recognized or disclosed in the financial statements at fair value on a recurring basis on April 1, 2008, and on April 1, 2009 with regard to non-financial assets and non-financial liabilities. The adoption of these provisions did not have a material impact on our financial position, results of operations or cash flows.

In December 2007, the FASB issued a revision to previously issued accounting literature which changes the accounting for business combinations including: (i) the measurement of acquirer shares issued in consideration for a business combination, (ii) the recognition of contingent consideration, (iii) the accounting for preacquisition gain and loss contingencies, (iv) the recognition of capitalized in-process research and development (IPR&D), (v) the accounting for acquisition-related restructuring costs, (vi) the treatment of acquisition-related transaction costs, and (vii) the recognition of changes in the acquirer’s income tax valuation allowance. This guidance applies prospectively to all business combinations beginning in fiscal 2010. The impact of adoption on our financial position, results of operations or cash flows will be dependent upon the nature and terms of business combinations that we may consummate in fiscal 2010 and thereafter.

In April 2008, the FASB issued guidance that amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. This guidance was effective for us beginning in fiscal 2010 and did not have a material impact on our financial position, results of operations or cash flows.

In June 2008, the FASB issued guidance clarifying that unvested share-based payment awards with a right to receive nonforfeitable dividends are participating securities and providing information on how to allocate earnings to participating securities to allow computation of basic and diluted earnings per share using the two-class method. This guidance was effective for us beginning in fiscal 2010 and requires retrospective application for periods prior to the effective date. The adoption of this guidance did not have a material impact on our computation of earnings per share. Refer to Note 7 for further information related to our computation of earnings per share.

In April 2009, the FASB issued guidance for estimating fair value when the volume or level of activity in a market for an asset or liability has decreased significantly. This guidance also provides information on identifying circumstances that indicate a transaction is not orderly (i.e., a forced liquidation or distressed sale). This guidance was effective for us beginning in fiscal 2010 and did not have a material impact on our financial position, results of operations or cash flows.

In April 2009, the FASB issued guidance that applies to investments in debt securities for which other-than-temporary impairments may be recorded. If an entity’s management asserts that it does not have the intent to sell a debt security and it is more likely than not that it will not be required to sell the security before recovery of its cost basis, then an entity may separate other-than temporary impairments into two components: (i) the amount related to credit losses (recorded in earnings) and (ii) all other amounts (recorded in other comprehensive income). This guidance was effective for us beginning in fiscal 2010 and did not have a material impact on our financial position, results of operations or cash flows.

In April 2009, the FASB issued guidance that requires disclosures about fair value of financial instruments in interim financial statements. This guidance was effective for us beginning in fiscal 2010, and because it applies only to financial statement disclosures, it did not have any impact on our financial position, results of operations or cash flows.

In May 2009, the FASB issued guidance that provides general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. This topic was previously addressed only in auditing literature. This guidance was effective for us beginning in fiscal 2010 and did not have a material impact on our financial position, results of operations or cash flows.

In July 2009, the FASB released the final version of its new “Accounting Standards Codification” (Codification) as the single authoritative source for GAAP. While not intended to change GAAP, the Codification significantly changes the way in which the accounting literature is organized, combining all authoritative standards into a comprehensive, topically organized database. All existing accounting standard documents were superseded and all other accounting literature not included in the Codification is considered nonauthoritative, other than guidance issued by the SEC. The Codification is effective for interim and annual periods ending on or after September 15, 2009. We adopted the Codification in our interim financial statements for the second quarter of fiscal 2010, which had no impact on our financial position, results of operations or cash flows.

(2) Business Combinations

In April 2008, we acquired all of the outstanding capital stock of BladeLogic, Inc. (BladeLogic), a leading provider of data center automation software, for $28 per share. This acquisition expanded our offerings for server provisioning, application release management, automation and compliance. The acquisition of BladeLogic’s outstanding common stock and other equity instruments resulted in total purchase consideration of $854.0 million, including approximately $19.9 million of direct acquisition costs. Approximately $50.3 million of the purchase price was allocated to purchased IPR&D and was expensed as of the acquisition date.

In August 2009, we acquired all of the outstanding capital stock of MQSoftware, Inc. (MQSoftware), a leading provider of middleware and enterprise application transaction management software, for purchase consideration of $26.5 million. This acquisition expanded our offerings for middleware infrastructure software. The acquisition of MQSoftware included approximately $7.3 million of acquired technology and $7.9 million of customer relationships, with weighted average economic lives of approximately three years, in addition to other tangible assets and liabilities. This acquisition resulted in a preliminary allocation of $18.5 million to goodwill that was assigned to the Mainframe Service Management segment. We are in the process of finalizing our assessment of the fair value of certain acquired assets and assumed liabilities, principally related to tax loss carryforwards and other deferred tax attributes, and will adjust the purchase price allocation when finalized.

(3) Financial Instruments

We measure certain financial instruments at fair value on a recurring basis using the following valuation techniques:

(A) Market approach – Uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.

(B) Income approach – Uses valuation techniques to convert future estimated cash flows to a single present amount based on current market expectations about those future amounts, using present value techniques.

The fair values of our financial instruments were determined using the following input levels and valuation techniques:

Level 1 classification is applied to any asset or liability that has a readily available quoted market price from an active market where there is significant transparency in the executed/quoted price.

Level 2 classification is applied to assets and liabilities that have evaluated prices where the data inputs to these valuations are observable either directly or indirectly, but do not represent quoted market prices from an active market.

Level 3 classification is applied to assets and liabilities when prices are not derived from existing market data and requires us to develop our own assumptions about how market participants would price the asset or liability.

The following table summarizes the activity in Level 3 financial instruments:

Investments

Our available-for-sale investments in debt securities were comprised of the following at September 30, 2009 and March 31, 2009:

Proceeds from the sale of available-for-sale securities, gross realized gains and gross realized losses were:

At September 30, 2009, we held auction rate securities with a par value of $70.4 million, of which securities with a par value of $53.1 million were classified as available-for-sale and a par value of $17.3 million were classified as trading. The total estimated fair value of our auction rate securities was $60.9 million and $60.0 million at September 30, 2009 and March 31, 2009, respectively. Our auction rate securities consist entirely of bonds issued by public agencies that are backed by student loans with at least a 97% guarantee by the federal government under the United States Department of Education’s Federal Family Education Loan Program. Substantially all of these bonds are currently rated investment grade by Moody’s or Standard and Poor’s. Auctions for these securities began failing in early 2008 and have continued to fail through October 2009, resulting in our continuing to hold such securities and the issuers paying interest at the maximum contractual rates. We do not believe that any of the underlying issuers of these auction rate securities are presently at risk or that the underlying credit quality of the assets backing the auction rate security investments has been impacted by the reduced liquidity of these investments. Due to the illiquidity in the auction rate securities market caused by failed auctions, we estimated the fair value of these securities and the put option discussed below using internally developed models of the expected cash flows of the securities which incorporated assumptions about the expected cash flows of the underlying student loans and discounts to reflect a lack of liquidity in the market for these securities.

In November 2008, we entered into a put agreement with a bank from which we have acquired certain auction rate securities with a remaining par value of $17.3 million and an estimated fair value of $15.4 million at September 30, 2009. Under the terms of the agreement, we have the ability to put these auction rate securities to the bank at par value at any time during the period beginning June 30, 2010 and ending June 30, 2012. The bank also has the right to repurchase these auction rate securities at par value on or before June 30, 2010. These auction rate securities have been reclassified to trading securities and, accordingly, any changes in the fair value of these securities are recognized in earnings. In addition, we have elected the option under GAAP to record the put option at fair value. The fair value adjustments to these auction rate securities and the related put option resulted in minimal net impact to the consolidated statements of operations for the quarter and six months ended September 30, 2009.

The unrealized loss on our available-for-sale auction rate securities, which have a fair value of $45.5 million at September 30, 2009, was $7.6 million at September 30, 2009 and was recorded in accumulated other comprehensive income (loss) as we believe the decline in fair value of these auction rate securities is temporary. In making this determination, we primarily considered the financial condition and near-term prospects of the issuers, the probability scheduled cash flows will continue to be made and the likelihood we would be required to sell the investments before recovery in market value or maturity. These available-for-sale auction rate securities have been in an unrealized loss position for greater than twelve months. Because of the uncertainty related to the timing of liquidity associated with these auction rate securities, these securities are classified as long-term investments at September 30, 2009 and March 31, 2009.

Derivative Financial Instruments

We operate globally and transact business in various foreign currencies. Our foreign currency exposures relate primarily to certain foreign currency denominated assets and liabilities, primarily non-U.S. dollar denominated accounts receivable, cash and intercompany balances held by U.S. dollar functional currency entities. To minimize the risk from changes in foreign currency exchange rates, we have established a program that utilizes foreign currency forward contracts to offset the risks associated with the effects of certain foreign currency exposures. Gains or losses on our foreign currency exposures are offset by gains or losses on the foreign currency forward contracts entered into under this program. These foreign currency forward contracts generally have terms of one month or less and are generally entered into at the prevailing market exchange rate at the end of each month. We do not use forward contracts for speculative purposes. While these foreign currency forward contracts are utilized to hedge foreign currency exposures, they are not formally designated as hedges, and therefore, the changes in the fair values of these derivatives are recognized currently in earnings. We record these foreign currency forward contracts at fair value as either assets or liabilities depending on the net settlement position of the foreign currency forward contracts with each respective counterparty at the balance sheet date.

The fair value of our outstanding foreign currency forward contracts that closed in a gain position at September 30, 2009 was $0.4 million and was recorded as other current assets in our condensed consolidated balance sheet. The fair value of our outstanding foreign currency forward contracts that closed in a loss position at September 30, 2009 was $3.2 million and was recorded as trade accounts payable in our condensed consolidated balance sheet. The notional amounts at contract exchange rates of our foreign currency forward contracts outstanding on September 30, 2009 and March 31, 2009 were:

The effect of the foreign currency forward contracts for the quarter and six months ended September 30, 2009 was a loss of $6.5 million and $20.6 million, respectively, which was offset by gains on our foreign currency exposure, resulting in $1.6 million and $2.1 million, respectively, of net expense recorded in interest and other income, net. The effect of the foreign currency forward contracts for the quarter and six months ended September 30, 2008 was a gain of $17.8 million and $14.0 million, respectively, which was offset by losses on our foreign currency exposure, resulting in $(1.0) million and $0.8 million, respectively, of net expense (income) recorded in interest and other income, net.

We are exposed to credit-related losses in the event of non-performance by counterparties to derivative financial instruments, but we do not expect any counterparties to fail to meet their obligations given their high credit ratings. In addition, we diversify this risk across several counterparties and utilize netting agreements to mitigate the counterparty credit risk.

Other Financial Instruments

The fair value of the senior unsecured notes due 2018 at September 30, 2009 and March 31, 2009, based on market prices, was $335.6 million and $275.1 million, respectively.

The carrying values of all other financial instruments, consisting of cash and cash equivalents, non-marketable securities and receivables, approximate their respective fair values.

(4) Long-Term Debt

Long-term debt consists of the following:

At September 30, 2009, we were in compliance with all debt covenants.

(5) Income Taxes

Income tax expense was $38.4 million and $38.9 million for the quarters ended September 30, 2009 and 2008, respectively, resulting in effective tax rates of 29.0% and 35.8%, respectively. Income tax expense was $63.5 million and $59.1 million for the six months ended September 30, 2009 and 2008, respectively, resulting in effective tax rates of 26.4% and 45.4%, respectively. The effective tax rate is impacted primarily by the worldwide mix of estimated consolidated earnings before taxes and our policy of indefinitely re-investing earnings from certain low tax jurisdictions, additional accruals and changes in estimates related to our uncertain tax positions, benefits associated with income attributable to both domestic production activities and the extraterritorial income exclusion and the non-deductible expense from the write-off of IPR&D assets associated with certain acquisitions. The higher effective tax rate for the six months ended September 30, 2008 was attributable primarily to the non-deductible expense from the write-off of IPR&D assets in connection with our acquisition of BladeLogic, Inc.

We file a federal income tax return in the United States as well as income tax returns in various local, state and foreign jurisdictions. Our tax years are closed with the United States Internal Revenue Service (IRS) through the tax year ended March 31, 2003. During fiscal 2009, we filed a petition with the United States Tax Court in response to a Notice of Deficiency received from the IRS for the tax years ended March 31, 2004 and 2005 and during the quarter ended June 30, 2009 the United States Tax Court scheduled a trial date for later in the current fiscal year. During the quarter ended September 30, 2009, we jointly filed a motion for continuance with the IRS to the tax court which was granted. However, we have not received notice on a new trial date. We have recently begun settlement discussions with the IRS on certain issues and believe it is reasonably possible they will be concluded in the next twelve months; however, the ultimate outcome of these discussions cannot be reasonably estimated at this time. During fiscal 2009, the IRS completed its examination of our United States federal income tax returns for the tax years ended March 31, 2006 and 2007 and issued a Revenue Agent Report (RAR) thereon. We have filed a protest letter contesting certain adjustments included in the RAR and settlement discussions with the IRS Office of Appeals are scheduled to begin later in the current fiscal year. The IRS has initiated an examination of our federal income tax return for the tax year ended March 31, 2008. In addition, certain tax years related to state, local and foreign jurisdictions remain subject to examination. To provide for potential tax exposures, we maintain a liability for unrecognized tax benefits which we believe is adequate.

(6) Share-Based Compensation

During the six months ended September 30, 2009, we granted share-based awards to our executive officers and non-executive employees consisting of 0.2 million options to purchase our common stock and 1.4 million shares of time-based nonvested stock units. The time-based nonvested stock units vest in annual increments over three years.

The fair value of share-based payments was estimated using the Black-Scholes option pricing model with the following weighted-average assumptions:

At September 30, 2009, we have approximately $164.8 million of total unrecognized share-based compensation expense related to stock options, nonvested stock and nonvested stock units that is expected to be recognized as expense over a weighted-average period of two years.

Share-based compensation expense as recorded in our condensed consolidated statements of operations is summarized as follows:

(7) Stockholders’ Equity

Earnings Per Share

The two-class method is utilized for the computation of earnings per share (EPS). The two-class method requires a portion of net income be allocated to participating securities, which are unvested awards of share-based payments with nonforfeitable rights to receive dividends or dividend equivalents, if declared. Income allocated to these participating securities is excluded from net earnings allocated to common shares, as shown in the table below.

Basic earnings per share is computed by dividing net income allocated to common shares by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income allocated to common shares by the weighted average number of common shares outstanding during the period, plus the dilutive effect of outstanding stock options and other dilutive securities using the treasury stock method.

The following table summarizes the basic and diluted EPS computations for the quarters and six months ended September 30, 2009 and 2008:

For the quarters ended September 30, 2009 and 2008, 5.9 million and 10.2 million weighted average potential common shares, respectively, have been excluded from the calculation of diluted EPS, as they were anti-dilutive. For the six months ended September 30, 2009 and 2008, 8.1 million and 8.8 million weighted average potential common shares, respectively, have been excluded from the calculation of diluted EPS, as they were anti-dilutive.

Treasury Stock

Our Board of Directors had previously authorized a total of $3.0 billion to repurchase common stock. During the quarter and six months ended September 30, 2009, we purchased 2.1 million and 3.6 million shares, respectively, for $75.0 million and $125.0 million, respectively, under these authorizations. At September 30, 2009, approximately $219.8 million remains authorized in the stock repurchase program, which does not have an expiration date. In addition, during the quarter and six months ended September 30, 2009, we repurchased 0.1 million and 0.2 million shares, respectively, for $2.4 million and $7.3 million, respectively, to satisfy employee tax withholding obligations upon the lapse of restrictions on nonvested stock grants.

(8) Guarantees and Contingencies

Guarantees

Under our standard software license agreements, we agree to indemnify, defend and hold harmless our licensees from and against certain losses, damages and costs arising from claims alleging the licensees’ use of our software infringes the intellectual property rights of a third party. Also, under these standard license agreements, we represent and warrant to licensees that our software products operate substantially in accordance with published specifications.

Other guarantees include promises to indemnify, defend and hold harmless each of our executive officers, non-employee directors and certain key employees from and against losses, damages and costs incurred by each such individual in administrative, legal or investigative proceedings arising from alleged wrongdoing by the individual while acting in good faith within the scope of his or her job duties on our behalf.

Historically, we have not incurred significant costs related to such indemnifications, warranties and guarantees. As such, and based on other factors, no provision or accrual for these items has been made.

Contingencies

We have received claims from a third party alleging that we infringe on one or more of the third party’s patents. We believe that we have meritorious defenses to the claims and intend to vigorously contest them. Additionally, we have asserted counter-claims against the third party alleging infringement on certain of our patents. No formal proceedings have been initiated by either party and the ultimate outcome of this matter cannot be estimated at this time.

We are party to various labor claims brought by certain former international employees alleging that amounts are due such employees for unpaid commissions and other compensation. The claims are in various stages and are not expected to be fully resolved in the near future. We intend to vigorously contest all of the claims. However, the ultimate outcome of all of the claims cannot be estimated at this time.

In June 2006, we sought clarification from a Brazilian court as to whether a tax applies to the remittance of software payments from our Brazilian operations. The matter is currently being litigated in Brazilian courts. In February 2007, a law was enacted that clarified that this particular tax did not apply to the remittance of software payments, retroactive to January 1, 2006. We continue to pursue a favorable resolution on this matter for years prior to January 1, 2006. While we believe we will ultimately prevail based on the merits of our position, we cannot predict or estimate the timing or ultimate outcome of this matter.

In April 2009, a lawsuit was filed against us by Data Detection Systems, LLC in the United States District Court for the Southern District of Texas, Houston Division. The complaint seeks monetary damages in unspecified amounts and permanent injunction based upon claims for alleged patent infringement. We believe that we have meritorious defenses and intend to vigorously defend this matter. However, we cannot predict or estimate the timing or ultimate outcome of this matter.

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 matters will have a material adverse effect on our consolidated financial position, results of operations or cash flows.

(9) Segment Reporting

We are organized into two business segments, Enterprise Service Management (ESM) and Mainframe Service Management (MSM). The ESM segment derives its revenue from our service support, service assurance and service automation solutions, along with professional services revenue derived from consulting, implementation, integration and educational services related to our software products. The MSM segment derives its revenue from products for mainframe database management, monitoring and automation, enterprise scheduling and output management solutions.

Segment performance is measured based on segment operating income, reflecting segment revenue less direct and allocated indirect segment operating expenses. Direct segment operating expenses primarily include cost of revenue, selling and marketing, research and development and general and administrative expenses that can be specifically identified to a particular segment and are directly controllable by segment management, while allocated indirect segment operating expenses primarily include indirect costs within these operating expense categories that are not specifically identified to a particular segment or controllable by segment management. The indirect operating expenses are allocated to the segments based on budgeted bookings, revenue and other allocation methods that management believes to be reasonable. Our measure of segment operating income does not include the effect of share-based compensation expenses, amortization of acquired technology and other intangible assets, the write-off of purchased IPR&D or the costs associated with severance and exit activities described in Note 10, which are collectively included in unallocated operating expenses below. Assets and liabilities are reviewed by management at the consolidated level only.

The table below summarizes segment performance for the quarters and six months ended September 30, 2009 and 2008.

(10) Severance, Exit Costs and Related Charges

We have undertaken various restructuring and process improvement initiatives in recent years through the realignment of resources to focus on growth areas and the simplification, standardization and automation of key business processes. Additionally, we undertook general workforce reductions in the latter half of fiscal 2009 and in the first half of fiscal 2010, principally as a result of macroeconomic conditions. Related to these collective actions, we recorded charges of $0.5 million and $1.5 million during the quarter and six months ended September 30, 2009, respectively, and $1.5 million and $7.9 million during the quarter and six months ended September 30, 2008, respectively. These expenses were attributable primarily to identified workforce reductions and associated cash separation packages.

Activity related to the above initiatives during the six months ended September 30, 2009 is summarized as follows:

The accruals for severance and related costs at September 30, 2009 represent the amounts to be paid to employees that have been terminated or identified for termination as a result of the initiatives described above. These amounts are expected to be paid during fiscal 2010. We continue to review the impact of these actions and will determine if, based on future operating results, additional actions to reduce operating expenses are necessary. The amount of any potential future charges for such actions will depend upon the nature, timing, and extent of those actions.

The accruals for facilities costs at September 30, 2009 represent the remaining fair value of lease obligations for exited locations, as determined at the cease-use dates or lease modification dates of those facilities, net of projected 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 2014. Projected sublease income is based on management’s estimates, which are subject to change. We may incur additional facilities charges subsequent to September 30, 2009 as a result of the initiatives described above.

(11) Recently Issued Accounting Pronouncements

In June 2009, the FASB issued new guidance on accounting for transfers of financial assets, which amended previous GAAP literature. The amendment includes: (i) elimination of the qualifying special-purpose entity concept, (ii) a new unit of account definition that must be met for transfers of portions of financial assets to be eligible for sale accounting, (iii) clarifications and changes to the derecognition criteria for a transfer to be accounted for as a sale, (iv) a change to the amount of recognized gain or loss on a transfer of financial assets accounted for as a sale when beneficial interests are received by the transferor, and (v) extensive new disclosures. This guidance will be effective for us beginning in fiscal 2011. We have not determined whether its adoption will have a material effect on our financial position, results of operations or cash flows.