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BMC Software, Inc. (NASDAQ:BMC)

F2Q09 Earnings Call

October 30, 2008 5:00 pm ET

Executives

Derrick Vializ - Investor Relations

Robert E. Beauchamp - President, Chief Executive Officer, Director

Stephen B. Solcher - Chief Financial Officer, Senior Vice President

Analysts

Kevin Buttigieg - Stanford Group

Michael Turits - Raymond James

Philip Winslow - Credit Suisse

Abhey Lamba - UBS

John DiFucci - J.P. Morgan

Kirk Materne - Banc of America

Operator

Good day, everyone and welcome to today’s BMC Software second quarter fiscal year 2009 earnings results conference call. Today’s program is being recorded. At this time for opening remarks and introductions, I would like to turn things over to Mr. Derrick Vializ. Please go ahead, sir.

Derrick Vializ

Thank you, Operator and good afternoon, everyone. I’m Derrick Vializ, Vice President of Investor Relations and I would like to thank you for joining us today. During our call, Bob Beauchamp, our Chairman and CEO, will provided an overview of our second quarter performance, a review of the performance of our BSM and mainframe businesses. After that, Steve Solcher, our CFO, will provide additional financial and operational details. Bob will then provide an update on our expectations for fiscal 2009 before we open the call to questions.

The prepared comments were previously recorded. This call is being webcast and a complete record of the call will be made and posted to our website. In addition to today’s earnings press release, we have posted a presentation which we will refer to at various times during the call. Both of these documents are available on our investor relations website at bmc.com/investors.

Before we continue, I would like to remind you that the statements in this discussion, including statements made during the question-and-answer session regarding BMC's future financial and operating results, the development of and demand for BMC's products, BMC's operating strategies, acquisitions, and other statements that are not statements of historical fact are considered forward-looking statements.

These statements are subject to numerous important factors, risks, and uncertainties which could cause actual results to differ from the results implied by these or any other forward-looking statements. Cautionary statements relative to these forward-looking statements and BMC's operating results are described in today’s earnings press release and the financial presentation and in our annual report on Form 10-K.

All of these documents are available on our website. These forward-looking statements are made as of today based on certain expectations and we undertake no obligation to update these forward-looking statements.

I would also like to point out that the company’s use of non-GAAP financial measures is explained in today’s earnings press release and a full reconciliation between non-GAAP measures and the corresponding GAAP measure is provided in the tables accompanying the press release and in our GAAP to non-GAAP reconciliations found on our website at BMC.com/investors.

At this time, I will turn the call over to Bob.

Robert E. Beauchamp

Thank you, Derrick. Good afternoon, everyone and thank you for joining us on today’s call. I am pleased to report that BMC Software had a strong second quarter, despite the continuing uncertainty in the global markets.

Our performance reflects the tangible value that our BSM solutions offer customers in both good and difficult economic environments. It also underscores our relentless focus on execution in terms of quickly integrating acquisitions like Blade Logic, strengthening our go-to-market capabilities, and managing our expense base.

During the quarter, our key metrics, total bookings, licensed bookings, revenue, non-GAAP operating margin, and non-GAAP EPS, improved significantly compared to the prior year.

Total bookings were $408 million, up 20%. ESM license bookings increased 42%. We achieved double-digit percentage year-over-year growth in total revenue for the fourth consecutive quarter. Total revenue increased 11% and at constant currency increased 9% to $467 million, with growth in all major geographies.

Non-GAAP operating margin was 32%, up from 28%. Non-GAAP operating margin for our enterprise service management business was up four percentage points and doubled sequentially. Non-GAAP operating margin for our mainframe service management business was also up four percentage points. Non-GAAP diluted EPS rose 19%. Our balance sheet remained strong with over $1 billion in cash and investments.

While we are optimistic about our business and pleased with our second quarter performance, we do face currency headwinds because of the recent rapid strengthening of the U.S. dollar. We are also mindful of the impact that current global economic conditions and the credit crunch may have on IT spending.

As you already know, many analysts have expressed their concern regarding the health of the economy and the appetite of companies for spending on IT. That said, we nevertheless believe there are fundamental aspects to our business that make BMC much better positioned than other software providers as well as the broader field of IT vendors.

First, our business service management and mainframe service management solutions addressed customers’ top spending priorities as cited in the most recent IT spending surveys.

Our BSM solutions help our customers meet their business objectives to comply with internal and external business and regulatory standards, more effectively manage their risk, and significantly improve their productivity and efficiency.

Our mainframe solutions are critically important to our larger enterprise customers by helping them consistently meet service objectives while lowering their cost of mainframe management and scheduling operations. These tangible benefits resonate with customers during periods of slower economic activity, as well as in periods of growth.

Second, our business model and business mix includes a large block of both reoccurring and multi-year business that provides us with a relatively high level of visibility in terms of our future revenue streams.

A substantial portion of our quarterly revenue represents deferred revenue coming off our balance sheet, which enhances our revenue visibility. Additionally, with a large percentage of BMC's business being maintenance from a very credit-worthy customer base, we have a solid business that gives us a competitive advantage at this time.

Third, BMC delivers very high ROI with short pay-back periods. In the current business environment, a top priority for many large enterprises is to design, select, and install the platform to manage their IT environments for the next decade. We hear again and again, and our business results demonstrate, that BMC is viewed as a superior choice in comparison to our competitors.

Fourth, BMC sells into a diverse set of industries and geographies. Our bookings and revenue base reflect this reality. For example, while we count almost all major companies within the financial services and banking industry as customers, our revenue exposure to this vertical is in line with our industry.

And fifth, for the past five years, this management team has consistently proven that we can drive increased productivity within our organization. Our disciplined approach creates significant operating leverage for us as we convert a higher percentage of incremental revenue dollars into profit.

Let me now transition to discuss our BSM performance. Overall, we continued to build strong momentum with BSM. This market strength is reflected by the continued progress in new sales and in the way we have increased our overall footprint with customers. As you have seen in our announcements and news coverage, many customers have decided to standardize on our BSM solutions. In the second quarter, there was a large increase in average deal size across all BSM disciplines. Last year, we completed seven deals over $1 million in ESM license bookings. In this quarter, we completed 23 such deals, with more than $1 million in ESM license bookings. So far in fiscal 2009, we have gained 300 new customers for our ESM solutions.

To help our customers achieve the potential of BSM, we have focused our offerings around three disciplines -- service automation, service support, and service assurance. Our first discipline is service automation, which automates repetitive and manual tasks to reduce the margin of error and allow IT to get things done more quickly. It also makes compliance standards and policies actionable. As a result, our customers can reduce the impact related to configuration change by up to 90%. This area is particularly important to customers who are going through budget tightening and industry consolidation.

We had strong growth in license bookings in our service automation business. Even in the current macroeconomic environment, market demand for the automation of IT processes is robust. In particular, our server provisioning and compliance solutions had a very strong quarter.

The acquisition of Blade Logic enabled us to create the industry’s new leader in IT service automation, the fastest growing part of BSM. We think that there is an extraordinary opportunity in service automation. The increased complexity of IT environments and focus to drive cost out of IT is driving this opportunity.

Our second discipline, service support, reduces complexities, improves customer service as perceived by the end users, and helps drive efficiency improvements. Our customers can fast-track their IT initiatives by up to 50%.

I am pleased to say that we continue to see significant wins and competitive displacements in service support. While during the quarter we saw a decline in service support license bookings, we believe the second quarter performance is an execution related anomaly. Our ESM sales force temporarily shifted their focus to realize the increased demand for our Blade Logic solutions portfolio. Year-to-date, service support license bookings increased 8%.

The third discipline, service assurance, is vectoring into an exciting new growth segment of our market, focused on predictive intelligence for IT operations. It delivers automation and predictive technologies to help our customers find, prioritize, and fix issues before they can impact their business. We are pleased with the results and growth we generated in the second quarter and we remain focused on strengthening and growing our service assurance business.

During the quarter, we continued to strengthen the BMC sales organization by increasing and improving solutions training and by emphasizing cross-selling across our BSM disciplines. Our goal is to significantly increase our book of business among U.S. and international companies, those that we have an existing relationship with and those that we do not.

During the quarter, BMC signed important new contracts with various enterprises worldwide. In Europe, Finanz Informatik, one of the world’s largest IT service providers, formed by the merger of two companies in Germany, selected BMC as their service assurance standard. In addition, we strengthened our relationship with Postbank, the leading multi-channel bank in the German market. Postbank will improve their operating excellence and cut costs by automating server configuration management.

Finanz Informatik and Postbank are convinced that our BSM and MSM strategies are the right fit for their IT operations. Both enterprises appreciate the integrated approach in technology of our two business units. It’s worth noting that Finanz Informatik and IBM recently announced an agreement in which IBM will help Finanz Informatik improve and transform its IT and data center infrastructure, but at the same time within that framework, Finanz Informatik chose to standardize its mainframe and service assurance technologies on BMC.

In the U.S., one of our largest BSM sales wins was Verizon, the tel-com leader. Verizon is consolidating the IT functions of its subsidiaries and standardizing them all on BMC, with a goal to increase efficiency and cost reduction. This highly competitive win puts BMC in a great position to market new functionality and increase our business with Verizon for years to come.

Other sales wins in the U.S. include Target, Hewitt Associates, Kohl’s and Kroger. Target has adopted our BladeLogic solutions and we believe this to be the largest service automation deployment of its type in the world. Hewitt Associates, one of the world's largest providers of multi-service HR business process outsourcing, chose BMC as their vendor of choice and key strategic partner. Hewitt fully implemented BMC’s IT Infrastructure and Event Management offerings. Kohl’s, another national department store chain, expects to streamline and ease the implementation of their Configuration Management implementation with our BMC Discovery solutions. And Kroger, one of the nation's largest grocery retailers, decided to replace their offering from one of our major competitors with our solutions to consolidate all event sources into one Event Management System.

The aforementioned wins demonstrate the power of our BSM solutions to deliver tangible value even in industries facing difficult economic environments.

It is clear that customers are gravitating towards a strategic management platform focused around Business Service Management. BMC continues to lead the competition in BSM capabilities and integrations. Our strategy and solutions are resonating with customers around the world in a broad range of industries.

Turning now to our MSM unit, execution on our strategy has been successful and unwavering. During the quarter, we continued to increase the MSM installed base by adding 25 new customers. We expanded our footprint in strategic accounts where 41 of our existing customers added new mainframe solutions. As seen with Finanz Informatik and Postbank, we once again increased the customer annual run rate on our largest enterprise transactions.

The mainframe market continues to be highly stable, in terms of demand and pricing. And as you can see from our results, our MSM unit continues to be quite successful in contributing to the overall company’s improved profitability.

As we move forward into the second half of fiscal 2009, I want to close by reiterating our key objectives for the rest of the year.

First, we will extend our leadership in BSM by maintaining our highly focused approach in our delivery of our Service Support, Assurance, and Automation solutions.

Second, in our MSM business we will continue to focus on increasing our customers’ run rate of spend, broadening our footprint in existing customers and winning competitive replacements while optimizing our profitability and cash flow.

And third, we will remain highly disciplined in how we run our business in order to yield greater sales productivity and business process efficiencies to support long-term growth.

I have been working for some time to maximize the performance of our two business units. One of the most important ways in which we’re driving to continue our excellent performance is by ensuring that we have a world class management team.

Today I am pleased to announce the appointments of the following members of BMC’s executive leadership to new and critically important posts: Bill Miller to the position of President of our mainframe service management business unit. As you know, Bill has been leading this unit very successfully for a number of years. In this role, Bill is in charge of all MSM research and development, sales, support and go-to-market activities.

Dev Ittycheria has been named President of our Enterprise Service Management business unit. In his new role, Dev is in charge of all ESM research and development, sales, support and go-to-market activities.

Jim Grant has been named Senior Vice President, Corporate Strategy and Development. Jim will head all of our company-wide strategy efforts, merger & acquisition activity, strategic alliance development, and corporate marketing activities.

BMC is well-positioned in the current global economic environment. As cited in recent IT spending surveys, software investment will not stop, even with the most-pessimistic forecasts for the economy and within the overall software industry, the best growth rates are in enterprise software.

We’ll talk more about our outlook for the second half of fiscal 2009 later on in the call. But let me first turn the call over to Steve Solcher, who will provide more insight into our financial results.

Stephen B. Solcher

Thanks Bob. We are pleased with our performance in the second quarter as both business units continued to demonstrate positive trends in many of their key metrics. Business fundamentals remain encouraging. In the quarter, we grew top line double digits while maintaining our expense structure leading to year over year margin expansion of four percentage points.

The steps that we have taken in the last several years to position the company for growth and scale should serve us well to weather uncertain times like these. We have focused on leveraging our infrastructure by reducing our cost and expense levels and improving our efficiency. Our business model is positively influenced by a large recurring stream of license and maintenance revenue which should position us well in today’s environment.

While we generally feel good about our underlying business and performance, we are cautious given the uncertainties surrounding the broader market. We are closely watching our key management metrics, such as pipeline, close rates, Days Sales Outstanding, financing activity, headcount and pricing trends.

As we have proven in the past, we are an agile company that has the ability to move quickly and decisively to adjust our expense base in order to maintain and improve our profitability.

With that, let me start by reviewing these financial results in more detail.

Non-GAAP operating income increased by 25%, from $119 million to $149 million in the second quarter. Our second quarter non-GAAP operating margin was 32%, up from 28% in the year-ago quarter. We expect continued year-over-year improvement in our non-GAAP operating margin throughout the rest of fiscal 2009.

Please refer to slide five for our non-GAAP income statement, which includes segment profitability of our ESM and MSM business units.

Both business units had increases in profitability compared to the prior year with ESM’s non-GAAP operating income increasing to $40 million from $23 million. During the quarter, ESM’s operating margin increased year over year by four percentage points to 14%, and doubled compared to the first quarter. We are pleased with the progress we made in improving the profitability of our ESM business and expect continued year-over-year improvements in ESM’s non-GAAP operating margins throughout the remainder of fiscal 2009.

Our MSM business remains highly profitable and stable. MSM’s non-GAAP operating income increased year over year by 14% to $109 million and its non-GAAP operating margin increased by four percentage points to 58%.

Non-GAAP net earnings for the second quarter were $108 million, an increase of 13% over fiscal 2008. Non-GAAP diluted EPS for the period was $0.56, up 19% compared to the year-ago period. This reflects a non-GAAP effective tax rate for the quarter of 29%. These non-GAAP results reflect diluted shares outstanding in the second quarter of 192 million, versus 202 million in the year-ago period.

GAAP operating income in the second quarter of fiscal 2009 was $106 million, compared with $91 million in the year-ago quarter. GAAP net income and fully diluted EPS were $70 million and $0.36, compared to $77 million and $0.38 in the second quarter of fiscal 2008.

Turning now to bookings, total bookings for the second quarter of 2009 were $408 million, an increase of 20% compared to the year-ago period.

Total bookings on a trailing 12 month basis were $1.9 billion, up 6% compared with the year ago period. The weighted average contract length for total bookings on a trailing 12 month basis was 2.1 years, down from 2.4 years in the year ago period.

With the increase in bookings and reduction in contract length, trailing twelve month annualized bookings for the second quarter increased 20% over the year ago period to $887 million. This is the eleventh consecutive quarter of annualized bookings growth on a trailing twelve month basis. Please refer to slide 7 in our presentation.

Now let me turn to the performance of each of our business units. For our ESM business unit, license bookings are the best measure of performance. ESM license bookings were $120 million in the second quarter, up 42% over the year-ago period. On a pro forma basis, or if we had included BladeLogic’s results in the year-ago-quarter, ESM license bookings would have risen 24%.

During the quarter, license bookings for Service Automation were $30 million, compared to $5 million a year ago. On a pro forma basis, Service Automation license bookings would have risen 73%.

License bookings for Service Assurance were $36 million, up 84%. This product discipline has characteristics similar to that of our MSM business unit, which include large multi-year transactions; therefore, performance can be lumpy.

License bookings for Service Support were $54 million, down 10% year over year but up sequentially 4%. For the first half of fiscal year 2009, service support license bookings are up 8%. We do not believe second quarter results reflect a fundamental shift in the long-term prospects of this product discipline.

For license bookings trends, please refer to slide 9 in our presentation.

Turning to our Mainframe unit, we believe the MSM business unit is best evaluated on the basis of total and annualized bookings over the trailing twelve months. In the second quarter, total MSM bookings on a trailing twelve month basis remained flat at $766 million. The average contract length was 2.9 years, versus an average contract length of 3.1 years in the year ago period.

After normalizing for contract length, total annualized MSM bookings for the trailing 12 months were up 8% to $264 million. We are pleased with the performance of this business unit but continue to point out the mainframe business is lumpy and as a result, bookings can vary quarter to quarter.

Turning to revenue: total revenue for the quarter was $467 million, an 11% increase compared to the second quarter of fiscal 2008. This was the fourth quarter in a row with double-digit total revenue growth. On a constant currency basis revenues grew 9%. Given the recent strengthening of the dollar, we expect this trend to reverse and for currency to negatively impact revenue growth for the remainder of the fiscal year.

License revenue in the second quarter was $176 million, an increase of 16% compared to a year ago. ESM license revenue was $105 million -- that’s an increase of 23%. MSM license revenue increased by 8% to $71 million.

During the quarter, the percentage of license bookings that was deferred was 49%, which was higher than the 45% in the year-ago period. One of the key drivers for this increase in the ratable rate was the higher amount of term based transactions that we signed during the quarter.

For the second quarter, maintenance revenue was $256 million, up 6% compared to a year ago. ESM maintenance revenue was $138 million, up 7% and MSM maintenance revenue was $117 million, up 5% compared to the second quarter of fiscal 2008.

Professional services revenue, which is included in the ESM segment, increased by 25% to $36 million. Year over year, we saw continued improvement in the performance in our professional services business, as this business delivered a slight profit in the second quarter versus a loss a year ago.

From a geographic perspective, total revenue and license revenues grew in all major regions for the quarter, with particular strength in North America.

Moving next to operating expenses, we maintained our discipline in controlling expenses. Non-GAAP operating expenses were $318 million, an increase of 5% from the year-ago period due to increased costs from acquisitions and the negative impact from currency movements. Non-GAAP operating expenses were down $9 million sequentially.

Looking at our business units, ESM’s non-GAAP operating expenses were $239 million, compared to $220 million in the year-ago quarter. MSM’s non-GAAP operating expenses were $79 million compared to $82 million in the year-ago quarter.

During the second quarter as the broader market uncertainty grew, we initiated expense management actions around hiring and discretionary expenses to ensure that we were able to meet our full year objectives. These additional savings are reflected in the guidance that Bob will provide later.

In spite of these actions, we are committed to product innovation and to enhancing our go-to-market capabilities. We remain focused on improving our productivity by streamlining key business processes throughout the company.

Over the last several years, we have maintained a strong operating and financial discipline and we will continue to do so as we move into the second half of 2009. We remain confident in our ability to improve margins and enhance shareholder value and will continue to react as needed to the demand environment.

Other Income in the second quarter was $3.2 million. This primarily reflects the lower market yields on lower cash balances and interest expense. Our investment policy remains focused on liquidity and the preservation of principal. Given current market conditions, we expect Other Income to be neutral to our earnings for the remainder of fiscal 2009.

Turning now to the balance sheet: our balance sheet and capital structure remain solid. During the quarter, our collection efforts were strong and highly effective. We are seeing no significant impact from the current environment.

In today’s credit crunch, we believe our customer financing program is an important competitive advantage for BMC and our customers. Through this program, creditworthy customers obtain financing arrangements at competitive interest rates. Demand from third party financial institutions, which purchase these payment streams, remains solid.

Total deferred license revenue at the end of the second quarter was $566 million, a record level, representing an increase of $12 million sequentially.

During the quarter, we deferred $92 million of license revenues, or 49% of license bookings, and recognized $79 million of deferred license revenue from the balance sheet.

Total deferred revenue decreased by $59 million sequentially to $1.76 billion. This reflects our normal seasonality.

Software development costs on the balance sheet were $112 million, slightly up from the first quarter of 2009, as we capitalized $16 million and amortized $15 million during the quarter.

Cash and marketable securities at September 30th totaled $1.01 billion. Our net cash position was approximately $700 million.

For the quarter, cash flow from operations was $75 million, compared to $154 million in the prior period and in line with our expectations. The decline compared to last year reflects lower other income and seasonal impacts from working capital.

During the second quarter, we repurchased 3.1 million shares for an aggregate value of $100 million. We have approximately $475 million remaining in our existing repurchase program.

With that, I’ll turn the call back over to Bob for his concluding remarks.

Robert E. Beauchamp

Thank you, Steve. Let me now update you on our current outlook for fiscal 2009. Given our strong performance in the first half of the year, we are raising our expectations for full year non-GAAP earnings per share. We now expect non-GAAP earnings per share in the range of $2.15 to $2.25 with a seasonal pattern similar to prior years.

As we’ve discussed, we expect that the rapid strengthening of the dollar will have a negative near-term impact on our company’s results. We also believe that customer demand for our solutions remains relatively strong given the environment that we are in. With an uncertain global economic climate, however, we recognize that some customers may decide to reduce or defer IT spending. While we have not seen any material evidence of this so far, we do believe it is prudent to reflect a more cautionary outlook.

As a result, we’ve lowered our expectation for total bookings growth in 2009 from a low double digit increase to a mid single digit increase. About half of the decline in our revised bookings growth rate is due to an assumed negative currency impact. Therefore, we now expect cash flow from operations to be between $600 million and $650 million.

In terms of what this means for revenue, due primarily to our assumption of the negative currency impact in the second half, we now expect total revenue growth in the high single digits.

Our non-GAAP EPS range excludes an estimated $0.95 cents of special items including expenses related to the amortization of acquired technology and intangibles, in-process research and development associated with our acquisition of BladeLogic, stock-based compensation and restructuring activity.

We reiterate the following assumptions underlying our revised expectations: a license bookings ratable rate slightly higher than last year’s; a continued improvement in non-GAAP operating margin; other income that reflects the current interest rate environment; and a non-GAAP effective tax rate of 30%.

With that we will now turn the call over to questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) We will go first to Kevin Buttigieg with Stanford Group.

Kevin Buttigieg - Stanford Group

Thank you. Just on the outlook then, you mentioned slightly reducing the revenue and the total bookings growth rates -- about how much of that did you say was attributable to currency and how much of that would you say would be attributable to just kind of taking a cautious look at the outlook.

Stephen B. Solcher

Kevin, for the full year, it’s going to be different on both, so -- I’ve got a little echo here -- on bookings, it’s going to be about three points for currency for the full year and about a point or two for the broader macro market and then on revenue, we are really not taking anything down for the broader market and the growth is impacted about a point for currency.

Kevin Buttigieg - Stanford Group

Okay, and then you are more than making that up on the EPS side with the cost savings?

Stephen B. Solcher

That’s correct.

Kevin Buttigieg - Stanford Group

Would it be a similar impact on the cash flow side as well?

Stephen B. Solcher

You know, the cash flow, probably not as impactful. On the bookings side, because some of that macro -- or actually, let me backtrack, some of that currency impact is going to be in the fourth quarter and that will not impact cash flow for this fiscal year.

Kevin Buttigieg - Stanford Group

Okay. And what about the -- how did the quarter shape up at the end of the quarter? A number of other players out there have sort of talked about seeing a weakness emerge in the last couple of days. Did you see anything like that?

Robert E. Beauchamp

Kevin, we did not. In fact, we were a little bit holding our breath to see if that was going to happen to us and we had absolutely no evidence of it. And we saw the transactions we had in flight come in and we had a few that came in a day or two late, but everything came in that -- no deals disintegrated as a result of the economy, nor did it even come up in the discussions as we went through our close of quarter, those last few days. We didn’t hear that the company pulled back, any of our customers pulled back. The deals lined up and went down just like a normal quarter.

Kevin Buttigieg - Stanford Group

Okay, great. And then you mentioned 300 new customers on the ESM side -- are those new to your ESM or are they completely new customers to BMC?

Robert E. Beauchamp

BMC.

Kevin Buttigieg - Stanford Group

Great. Thank you very much.

Operator

We’ll go next to Michael Turits with Raymond James.

Michael Turits - Raymond James

Two questions here -- first, Steve, on the expense side, can you talk to us a little bit about expenses in dollars, absolute dollar terms? You got a dollar reduction sequentially this quarter. Do you think you can keep it flat going forward? What do you think you can do sequentially on an OpEx and where do you think OpEx ends up for the year on a dollar basis versus last year? And obviously maybe if you can make allowance for BladeLogic there, that would be helpful.

Stephen B. Solcher

Okay, so on a -- so sequentially, expenses went down $9 million from the first quarter. I would expect you to see some of that continue going forward. I think sequentially it will actually go up in Q3 and Q4.

For the full year, we just ended the quarter with 32% operating margins. For the remainder of the second half, I would expect us to be somewhere close to that, probably with third quarter being slightly better and fourth quarter coming back, so that we end the full year a little bit north of 30% of gross margins, or what I would say op margins.

Michael Turits - Raymond James

Okay, so 3Q up and then 4Q down, expenses going up sequentially in each of the next couple of quarters, right?

Stephen B. Solcher

That’s correct.

Michael Turits - Raymond James

Okay. And then --

Stephen B. Solcher

Michael, just one thing on expenses -- we are watching the broader market very closely and I think depending on what happens here in this quarter and going forward, just like we’ve done this quarter, we are going to watch it hard and there are things that we are looking at. We look at discretionary expenses, we’re looking at infrastructure cost. You should think that we are going to take a really hard look at expenses going forward.

Michael Turits - Raymond James

So if things ease up a little bit, you have the potential to cut a little more?

Stephen B. Solcher

I think you should expect us to take a very hard look at expenses for the second half, even more beyond what I have referenced.

Robert E. Beauchamp

We are going to be aggressive.

Michael Turits - Raymond James

And then the second question is about bookings and revenues -- it seems -- you said you weren’t seeing any fall-off at the end of the quarter and yet, it seems that the revenue and bookings guidance could be -- argue to be conservative, if that’s the case, given rough cut, you think about five points of growth in margins and five points of growth in bookings and revenues might have come from [inaudible]. In the end, it kind of looks like low-single-digit revenue growth ex-[Blade] and kind of flat bookings ex-[Blade]. Am I right in looking at it that way?

Stephen B. Solcher

Yeah, I think that when -- I think what you are trying to get at is the constant currency organic growth rate of revenue and that has been pretty consistent. That’s probably been ranging between 3% and 5%. If you take out for the second half of the year, it’s going to be roughly the same.

On the revenue side, we are taking probably a little bit more conservative view on the booking side but on the revenue side, we are looking for more of the same, so I wouldn’t look for a lot of upside. We are building in an expectation that the deferral rate increases in the second half. That’s going to slow revenue growth slightly.

Robert E. Beauchamp

And also I think without Blade is a very difficult thing to say because we have obviously trained our worldwide sales force on Blade. They have quotas for Blade so if they weren’t selling Blade, they would be selling the other products more aggressively and so it is now part of BMC 100%, and so it’s not a separate division at all and it affects the -- it is part of the total.

Michael Turits - Raymond James

If I could squeeze in a last one -- cash flow is coming down in terms of the guidance but generally there’s not an impact on cash flow, at least on the deferred revenue from currency, because that usually drops to the bottom line in currency impact and that deferred line is usually ex-currency. So why should -- is that coming down, cash flow coming down purely as a result of macro issues?

Stephen B. Solcher

It is, so it -- that’s the bookings decline, that’s the macro. So that’s the 1% to 2% that we talked about earlier. That cannot be offset by expense reductions.

Michael Turits - Raymond James

All right, guys. Thank you very much.

Operator

(Operator Instructions) We’ll go next to Phil Winslow.

Philip Winslow - Credit Suisse

Bob, just wondering if you could comment a little bit more on just the mainframe environment that you are seeing out there, just as far as what the buying trends of your customers are and as we just sort of go into an uncertain economic time here, what your expectations are. And then also Steve, just as one quick follow-up on the deferred line, I just want to make sure that the effect on bookings or on deferred, what you might expect that to be over the next few quarters from FX?

Robert E. Beauchamp

Sure. So mainframe just had another fantastic quarter and it’s fantastic in so many different ways. There’s really nothing not to like about the results. One of the things that I know we’ve told you about before is that we watch very carefully the average term length of our mainframe transactions and we look at our largest couple of dozen transactions every quarter to see whether or not, how our discounts are holding up, what the customer’s annual spend with us is and that is a -- that is strong double-digit growth in the high-teens in terms of what our customers are signing up for, more spend with us on an annual basis now. And so our mainframe business is growing very, very well on a competitive basis.

We believe that we are really winning significant share from our competitors in that area. We are seeing large transactions, we are seeing big customers select us, pick out new expanding products, so that product line has done extremely well under Bill’s leadership.

I would also say that in more difficult economic times -- in fact, one of the larger transactions we did this quarter was one of the few customers I know of who still says they are going to get rid of the mainframe, and they have said that for a number of years now, I would say probably about seven. But yet what they did with us today was sign up, or this quarter, last quarter was sign up for another multi-year deal with us and I think the economy helps that. I think that what they say is look, this mainframe platform is very competitive. It is running some of our most critical applications. Let’s lock it down and run it more efficiently as opposed to go through the expense of trying to re-host and move applications off into new systems where you need to go buy distributed servers and set up new systems and storage network, et cetera. They just leave the mainframe up and running and give it more to do.

And so I think that actually the mainframe in a tougher economic climate is a safe platform and we are in a very good position to take advantage of that.

Philip Winslow - Credit Suisse

And then Steve, just on the follow-up on the effect of currency on the deferred revenue and how you expect that to flow through into the cash flow statement.

Stephen B. Solcher

So the existing deferred balance, the currency really has zero impact. Those deferred balance is in dollars. You know, the vast majority of that, so currency will have no impact. The inbound stuff that’s been added to deferred revenue absolutely will have some currency impact and I think it will be slight but it will cause the deferred balance at today’s currency rates to be less than it would have been in a market where the dollar was weakening.

We still expect the deferred balance to grow.

Operator

We’ll go next to Abhey Lamba with UBS.

Abhey Lamba - UBS

Steve, you touched upon some of the key [times] that you keep track of. Can you give us some color on how they have been trending regarding your pipeline, close rates, DSOs? I think you already touched upon financing activities.

Stephen B. Solcher

So pipeline at least for the third quarter looks strong. It’s growing. Our close rates, we’re not expecting any real changes in close rates going forward. DSOs, you know, in the quarter the DSOs actually increased about three days, which was really nice. We are not expecting that to really move around. You know, so far what we are seeing is something that we think positively. That being said, we are still very cautious about the broader market.

Robert E. Beauchamp

One thing I will just mention on pipeline is that our -- John McMahon, our head of our ESM sales organization, has instituted some very focused initiatives around pipeline building and pipeline management that is in my 20-plus years with BMC, I have never seen anything better in terms of how to build a pipeline rapidly, and they have pipeline review sessions that are very focused, that John attends personally at a first line sales manager level. The organization is very focused on building pipeline because if the economy -- as the economy comes under stress, close rates is the most likely place you would see that show itself and our strategy on that is to make sure that we’ve got ample pipeline to counter that. So I am very encouraged by the pipeline that John is building. It is something he just started relatively recently. Obviously he’s only been on the job for short period of time but I believe over the coming quarters, you will see the impact of that really make it to the top line of BMC in a big way.

Abhey Lamba - UBS

Thanks, and Steve, can you quantify the impact of currency on your costs and upgrading income? And how should we trend those currencies kind of moving the other way?

Stephen B. Solcher

Well, on cost, I believe that -- I don’t think I have that number right off the top of my head. I want to say it’s about a percentage point right now. Revenues again, like I said earlier, what we are looking at is EPS for the full year to have zero impact from currency; second half we are looking at about a penny hurt. We had about a penny of help in the first half.

Abhey Lamba - UBS

Thank you.

Operator

We’ll hear now from John DiFucci with J.P. Morgan.

John DiFucci - J.P. Morgan

Thanks for taking my question. Steve, are you seeing -- given the current -- excuse me, I’m sorry -- given the current credit environment, is there any change, even on the margin, in dealing with third-party financial institutions out there? I mean, that’s not really a reflection of your business but it seems some people talking out there with investors, it’s perceived anyway that there is a risk that cash flow could be meaningfully affected in any given quarter, given your -- given the sale of receivables that you tend to do for large receivables.

Stephen B. Solcher

You know, it’s almost just the opposite. What we are seeing is most of this -- well, practically all of the paper is investment grade product and there continues to be an insatiable demand for this product today. You know, we’ve got a -- we’ve had a long history of selling this paper. We have relationships with most of the banks that are out there, especially high credit worthy banks. We are not seeing at all any slackening of this demand.

The only other thing I would put in perspective is you know, we are still only selling a small percentage of the total amount of paper, right, when you think about the total amount that’s out there. We’re talking about $30 million of paper a quarter. We’re not talking about a big amount of paper being sold to these financial third-party banks.

John DiFucci - J.P. Morgan

Okay, but even $30 million, like for instance, this quarter would have been a meaningful amount of the cash flow if you were seeing some push-back there but it sounds like you are not seeing it at all.

Stephen B. Solcher

We could have sold $90 million worth of paper -- I mean, there’s that much demand for the paper today.

Robert E. Beauchamp

I think the $30 million point, John, was the fact that it is not so much money that it affects the portfolios of the banks. These are fairly small numbers for the people that are buying the paper and in very recent conversations, they are ready to take more.

John DiFucci - J.P. Morgan

Okay, thanks. And just a follow-up, Bob, for you -- with BladeLogic and the integration of BladeLogic, and you made some pretty major changes in sales management, both here, worldwide, also in Europe. And that’s another thing that I think comes up a lot in discussion, which I sort of understand taking BladeLogic, this growth company, and instilling that within BMC, where it was in BMC but in different parts of it. But at the same time, just wondering how that’s going because there’s still a big part of BMC that caters to markets that are very different than what BladeLogic’s markets were like.

Robert E. Beauchamp

Sure. It’s going really very, very well, John. The discipline, the intensity, the quality of the hiring we are doing -- I mean, we have hired some of the very top sales people from -- I won’t name their names but our traditional -- we’ll call it the big four, some of their top sales people that come to work for us and in Europe particularly we’ve hired some. Just last week I received a phone call from the CEO of a reasonably large software company asking me for help in the fact that we appear to be attracting a top sales person from their organization, or one of their top sales people from their organization. We are able to attract -- there is a buzz around working for BMC right now in the top sales community that is very exciting. The quality of the management, I just returned -- I was in Europe. In the last six weeks, I spent a lot of time with customers and on the road and I was all through Europe visiting with the sales management teams. The intensity, the focus, the quality are up across the board.

Yes, there is always some concern whenever you have change. There’s always some concern that you lose some momentum. I think that to the extent that there was any short-term impact as a result of that change, it will be more than made up and quickly in years of better results for the company.

I just had our board meeting this last week and I told our board that one of the most exciting things happening at BMC right now is the sales cultural revolution that is going on within the company. It’s not without, as I mentioned, without some disruption to certain processes and ways that we have done things here but they know how to sell solutions.

By the way, I’ll give you some specifics. One of the things John is very, very intensely focused on is sales training, so he requires every sales person to pass testing standards on all of our major disciplines -- service assurance, service automation, and service support. Each sales person has to pass the test the first day of training, and then they go into a long sales training process for each one.

We’ll be starting here just in the next few weeks or the next month or so a new training program for the entire sales organization on BSM, so they will have done the individual circle, service support, assurance, and automation, then they do the atrium integration and then BSM total, so that every single sales person is certified internally on each of the product areas and in that certification, it’s how to sell hides, how to sell the entire platform, and so one of the early concerns that I had when I first met John was John, do you know how to sell solutions, are you a point product sales guy? And it took him about 15 minutes to convince me that he knows exactly how to sell solutions and it was simply a matter of adjusting his scan up a little bit, which he knows how to do intuitively and hires very strong sales people that know how to do it.

The sales calls I’ve made with some of the sales management, like in Europe, have been outstanding sales calls, very much of a CIO level sales calls.

John DiFucci - J.P. Morgan

Okay, thanks a lot, guys.

Robert E. Beauchamp

Thanks for asking that question, by the way. It’s something I’m excited about it.

Operator

We’ll take our final question today from Kirk Materne with Banc of America.

Kirk Materne - Banc of America

Thanks very much and Bob, this might be a little bit, just more of a follow-up on John’s question just around BladeLogic, but I guess two questions on BladeLogic -- number one, first of all we haven’t really seen that product maybe go through a downturn before and I think there is some perception that this is more of a nice-to-have technology and a little bit more expensive and something that people could potentially put off. Could you just I guess give me your thoughts around that?

And then secondly, if -- I apologize if I missed it before but could you just talk about your expectations and the ability for your sales guys to cross-sell BladeLogic with some of your other solutions, and whether or not that’s gone as you expected or better? Thanks.

Robert E. Beauchamp

Sure. So on the -- on your first question, I’ll just be really direct -- it couldn’t be more inaccurate to say that the product is a nice-to-have. Whoever told you that doesn’t understand what either Blade does or what is going on in the data centers.

I won’t name any names but let’s say this -- some of the world’s largest banks out there are very, very focused on this and in fact I was in a meeting yesterday with about eight people from one of the world’s largest banks and the entire discussion was around how they are having to go through a major consolidation as they have acquired other companies and that part of that is they have to drive $1 billion worth of cost out of their IT budgets. In those discussions, the only product that they were there to talk about that day was BladeLogic and how they intend to use it to try to drive out cost.

If you think about automation, Kirk, it is for -- I saw today that one of the major financial services companies announced lay-offs I think of 7,000 people. So if you announce lay-offs of 7,000 people and your IT organization is affected by that, where do you go first? And the answer is automation. And so I think if there was ever a product in BMC's history that is appropriately positioned in a tough economy, it’s our whole service automation product line. It’s about how to automate processes that were previously done manually and I don’t know of a single CIO today that’s not looking for ways to increase automation and reduce the long-term cost structure through automation. So I just -- I think I beat that to death but I’ll tell you, it’s extremely strong.

In terms of cross-selling, this is one of the major initiatives -- and in fact, I think we mentioned it in our prepared remarks, that we are really focused on as an organization, is how we cross-sell. One of the things that we’ve done with the sales force, John came in with a very strong opinion and one that we immediately adjusted to that he did not want a large amount of sales specialization in the sales force, that he believed that that would reduce cross-selling. And instead, all of our sales people, or virtually -- not all, but a vast majority of our sales people are now being trained on all of the product lines and with bonuses and compensation plans tied to it. So let’s say you are a sales person today who came from BladeLogic -- in order to hit your maximum accelerators, you must do cross-selling. You must sell other products in the portfolio in order to hit your maximum accelerator, so we built compensation systems in place to facilitate it. We’ve built sales education systems in place. We built accountability systems with the sales management in place where they are held accountable for ensuring that they are bringing up cross-selling. So there’s a lot of effort in how we do that.

Case in point -- this last quarter we closed a retailer in Canada, a company that had really felt the pressure of new competitors coming after them, global competitors entering their space. This retailer came to BMC. We presented the entire BSM story. They bought basically the entire story, the entire product line from service support, service automation, service assurance, professional services, the CMDV, really the full BSM suite from a company that if they were doing any business, I don’t know that they were a customer at all. If they were, they were a very small customer of ours and it went to a full standardization across the platform.

If you look at our ASPs this last quarter, you’ve seen our average sales price go up. Part of the reason for that is the amount of cross-selling going into the contracts. The number of million dollar transactions has gone up.

So there’s ample indications that cross-selling is not only something we are focusing on but it is working.

Kirk Materne - Banc of America

Great. Thanks for the color.

Robert E. Beauchamp

Well, with that, let me thank you all for joining us. As we mentioned in the call, we are extremely satisfied with the results we had in the first half of the year. We are looking to the second half of the year, obviously watching, reading the headlines that you are reading and that some of you are writing, and so we are going to be a little more cautious with that. We know how to manage expenses, we know how to invest and become more efficient, but most excitedly we know what the customers are asking for out there today and we think BMC is very well-positioned to take advantage of that and be a very competitive company, helping our customers through whatever they need to go through to make their goals.

With that, I look forward to talking with many of you one-on-one in the next days and weeks. Thank you.

Operator

That does conclude today’s conference. Have a pleasant day.

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Source: BMC Software F2Q09 (Qtr End 9/30/08) Earnings Call Transcript
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