BMC Software, Inc. F4Q06 (Qtr ended Mar 31, 2006) Earnings Conference Call Transcript (BMC)

BMC Software, Inc. (BMC)

F4Q06 Earnings Conference Call

June 7, 2006 5:00 p.m. EST

Executives

Bob Beauchamp, Chief Executive Officer

Steve Solcher, Chief Financial Officer

Derrick Vializ, Vice President Investor Relations

Analysts

Sarah Friar - Goldman Sachs

Michael Turits - Prudential Equity Group

Tim Klasell - Thomas Weisel

Presentation

Operator

Good day, ladies and gentlemen, and welcome to today’s BMC Software Fourth Quarter Earnings Results Conference Call. Just as a reminder, today’s call is being recorded. Now, at this time for opening marks and introductions, I would like to turn the conference over to Mr. Derrick Vializ. Please go ahead, sir.

Derrick Vializ

Thank you, Operator. 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 CEO, will provide an overview of our fourth quarter performance, provide you with an update on our Business Service Management strategy, and our fiscal 2007 priorities. After that, Steve Solcher, our CFO, will provide additional financial and operational details. Bob will then provide guidance for the 2007 fiscal year before we open the call to questions.

Before we continue, I would like to remind you that 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. I remind you also that numerous important factors, risks, and uncertainties affect BMC’s operating results and 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 available on our website at bmc.com/investors, and in our SEC filings.

I would also like to point out that the company’s use of non-GAAP financial measures is explained in today’s earning press release, and a full reconciliation between each non-GAAP measure and the corresponding GAAP measure is provided in the tables accompanying the press release.

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

Bob Beauchamp

Thanks, Derrick, and good afternoon. Thank you for joining our call.

Our fourth quarter results mark a solid ending to a year of significant improvement for our company. It also marks the fourth consecutive quarter we have met or exceeded guidance. During the quarter, we extended our leadership in Business Service Management and introduced new offerings that broaden and deepen our BSM portfolio.

We continue to realize the positive benefits of our cost-management actions earlier this year in terms of improved operating efficiency and profitability.

For example, non-GAAP operating margin rose from 3% in the fourth quarter a year ago to 17% in Q4 this year. For the full year, non-GAAP operating margin was 17%, up 9 percentage points.

We also continued our commitment to enhance shareholder value by significantly increasing the cash returned to shareholders through our aggressive stock repurchase program.

A central element of our business strategy is to extend our leadership in BSM. We are pioneers in this field, having launched our BSM strategy in April of 2003. BSM is clearly a key differentiator for us in the marketplace today. We are seeing more and more acceptance of it and greater understanding of the benefits it offers among industry analysts, customers, and not surprisingly, our competitors. We think BSM has reached a tipping point and it is entering the mainstream.

Today, we are seeing industry analysts endorse BSM. Let me quote from the Forrester research report, “Implementing BSM", dated April, 2006: “As 76% of the IT budget goes to operations, firms that implement BSM can potentially save 25% of their overall IT budget.”

Forrester added that developing true BSM systems requires two things: “Understanding the metrics business users employ to decide if IT is providing value, and linking these metrics and their associated business services to IT infrastructure components.” Later, BSM is further validated as “…the primary means for IT shops to move towards the goal of running IT more like a business.” In fact, Forrester expects the number of companies with revenues over $1 billion implementing BSM and integrated IT management will triple over the next two years.

Additionally, Gartner recently positioned BMC in its 2006 magic quadrant for IT service desk. Gartner placed BMC in the leader’s quadrant based on ability to execute and completeness of vision.

While we are pleased with the current views of industry analysts, customer acceptance of BSM and BMC solutions are ultimately what most matters. In the past quarter, new BSM customers such as Duke Energy, Eaton, and Caterpillar, chose BMC because of our ability to execute against what they believe is the right vision of BSM -- BMC’s vision.

Customer success is something that I am very passionate about and I would like to share a couple of examples with you.

By implementing BSM solutions, Mutual of Omaha, in a period of one year, has saved more than $4 million in downtime costs, enabling the company to be more proactive and consistent in delivering the levels of availability that their customers demand. Our solutions helped them to reduce database downtime by 66%, slash problem tickets by 60%, and improve back-up times by 50%.

Mutual of Omaha told us that: “By using a single solution versus many, our IT staff was able to replace several other vendor products, resulting in substantial savings, improved capacity management, increased efficiency, and significant cost avoidance.”

By standardizing on our BSM solutions, Förenings Sparbanken, one of the largest banks in the Nordic region of Europe with over 7 million customers, is now able to deliver high-quality, 24-7 business services over the Internet. This has resulted in an annual decrease in the number of face-to-face payment transactions at branch locations of 10%, allowing the company to increase the time spent on customer service by the working hour equivalent of 30 to 40 additional customer facing employees per year.

The growth in partner channel also demonstrates that our BSM strategy is attracting significant number of new adherents. Today, BMC is working closely with IBM Global Services, EDS, Perot Systems, Accenture, Cap Gemini and Bearing Point on key client opportunities. Most of the major outsourcing firms and systems integrators are standardizing on key components of BSM from BMC.

Competitor moves also form an interesting reference point. Virtually all of BMC’s competitors, large and small, have recently switched from criticizing BSM to adopting a BSM focus. However, none of them have the clarity of our vision and the breadth and depth of supporting product and solution offerings.

Most of them still have a lot of work to do in their labs. In stark contrast, we continue to introduce a wide array of new offerings that broaden and deepen our BSM portfolio. This includes the only second generation completely federated configuration management database, or CMDB, available in the industry today.

The BMC Atrium CMDB 2.0, shipping this month, also incorporates our new auto-discovery solution, which helps provide the critical technology for initial population and ongoing maintenance of a CMDB. This is an essential first step for implementing BSM, and we are the only one that has it all in one integrated federated solution.

Many of you are aware that that CMDB is a red-hot concept in IT right now, and BMC is uniquely positioned to capitalize on this important market trend. Many of our largest competitors are still laboring hard in their labs to produce their first CMDB offering. It is worth noting that we are moving into our second generation technologies, which were internally developed over the past two years. This testifies to our robust and innovative R&D efforts.

Last year, we identified transaction management as a large and emerging high-growth market. Through the combination of internal development and an acquisition, we have responded to a key customer need -- identifying, analyzing and resolving problems that affect transactions before they impact critical business services.

During the fourth quarter, we introduced BMC transaction management solutions, which provide the tools needed to measure and manage the performance of business transactions from the end-user perspective, across complex, heterogeneous computing environments.

Earlier this quarter, we closed on our acquisition of Identify Software, a leading global provider of application problem resolution and life cycle management software. Identify’s state-of-the-art technology offers unprecedented problem resolution capabilities that directly impact the way IT serves a customer’s business goals. Identify is now part of our new transaction management organization.

The acquisition of Identify enabled us to jump ahead of our competitors. Forrester noted: “By acquiring Identify Software….BMC Software does more than follow a technology consolidation trend. Instead, it acquires a product with unique transaction problem resolution capabilities through root cause analysis, capture, and playback. This acquisition propels BMC ahead of the curve in transaction performance management.”

We view this as a solid growth opportunity for BMC. Identify brings us access to new constituents. We plan to focus their sales force on selling Identify’s specialized offering to the application development and testing markets -- markets new to BMC Software.

As we move through fiscal 2007, our goal is to continue our positive momentum and drive for additional improvements in our results.

We’re focused on four principal areas:

The first is to accelerate growth in revenues by capturing the momentum around BSM;
Second, strengthen and improve the performance of our mainframe business;
Third, continue to effectively drive for efficiencies within our business processes, in order to continue to expand our operating margin while investing for growth in the future; and
Fourth, increase shareholder value, as the combination of these factors should enable us to deliver solid financial results and generate strong cash flow from operations, while supporting our aggressive share repurchase program.

For fiscal year 2007, we expect to achieve a non-GAAP operating margin of 20%.

Let me briefly discuss a few of our key internal moves aimed at achieving these goals.

If you recall in April of last year we announced the realignment of the sales force to provide greater focus to our growth businesses, while also dedicating sales specialists for our mainframe business. This year we made the next logical step in that progression.

Beginning with the first quarter of fiscal 2007, we have organized the company around two business units to optimize how we build value: The Enterprise Service Management business unit, or ESM; and the Mainframe Service Management business unit, or MSM.

Our Enterprise Service Management business now represents more than half of our revenues and integrates all our non-Mainframe technologies within a single organization. ESM is headed by Jim Grant, who joined BMC Software to run our Service Management business unit in March of 2003 from Hewlett Packard, where he was vice president and general manager of OpenView. Under Jim’s leadership, ESM is about to launch an extensive set of new BSM product offerings that will continue to extend our lead in this space.

Our Mainframe Service Management business unit consists of all our mainframe offerings, services and sales resources. MSM is headed by Bill Miller, who joined BMC Software in July of 2002 from BindView, where he was senior vice president and Chief Operating Officer. Bill also spent 21 years at IBM in various positions in sales, marketing and general management.

Both Jim and Bill report directly to me.

This new structure brings with it a number of important benefits. Each operating units’ market is driven by different dynamics. The new structure enables us to more effectively manage to these dynamics. It also brings greater clarity of purpose and increased focus on our go-to-market and product development efforts.

I want to stress -- we do believe there are important technology and sales synergies which span across both business units. For instance, all our strategic accounts will continue to be served by a single account manager.

The dynamics of the mainframe business are clearly unique. The customer base is more concentrated and it’s more mature but overall it continues to be an attractive market opportunity for us. In fact, IBM continues to reinvent and repurpose the mainframe platform to extend its central role in the enterprise as a critical computing platform for years to come.

Our goal of this new structure is to improve the bookings and profitability trajectory through focused sales and marketing execution. MSM will focus on total bookings and increasing cash flow, while ESM’s focus is on growing license bookings and expanding margins.

Our new structure will also help us to better align our strategy and resources with current market dynamics, to improve each respective business and optimize the business value proposition for our customers.

I’d like to sum up by saying that fiscal year 2006 has been a period of significant improvement for BMC. Today, we are a stronger, more competitive, more focused, more efficient and more profitable company that is driving to build value for our shareholders and customers.

We know, however, that we have more work to do.

Our key initiatives in 2007 – the organization of two focused and energized business units, along with our efforts to streamline and simplify our processes – are designed to keep our positive momentum going.

Let me now turn it over to Steve for a more detailed operational and financial review.

Steve Solcher

Thanks, Bob. I’d like to start off by briefly highlighting the significant improvements in profitability during the quarter and the year. Then I will discuss bookings, and take you through revenues and operating expenses. Following that, I will discuss our balance sheet and cash flow from operations.

During the fourth quarter, non-GAAP operating income increased by $59 million, or nearly 500%, to $71 million. Non-GAAP operating margin increased to 17% from 3% a year ago. For the full year, non-GAAP operating income more than doubled to $247 million. Non-GAAP operating margin was 17%, up 9 percentage points from the year ago period.

Non-GAAP diluted EPS also increased substantially compared to a year ago, to $0.35 for the quarter. For the fiscal year 2006, non-GAAP diluted EPS was $1.10, which was more than double when compared to fiscal 2005. Please note that non-GAAP diluted EPS in the fourth quarter and the full year reflects our actual tax rate for the respective periods.

For example, in the fourth quarter our actual tax rate of 16% had a positive impact on non-GAAP EPS by $0.05 compared to an estimated tax rate of 28%. This change in the use of our actual tax rate versus the estimated tax rate only impacts non-GAAP results, and does not have any effect on our historical GAAP results. Please refer to slide 15 to see the impact of the actual tax rate on non-GAAP net income and EPS for each quarter of fiscal 2006.

GAAP operating income for the fourth quarter was $59 million versus a loss of $14 million in the fourth quarter of last year. GAAP Net Income for the fourth quarter was $66 million or $0.31 per share, compared with $16 million or $0.07 per share in the year-ago period.

Diluted shares outstanding in the fourth quarter of 2006 were 216 million and in the fourth quarter of 2005 were 222 million.

License bookings were $173 million during the fourth quarter of 2006, versus $195 million in the fourth quarter of 2005, a decline of 11% compared to a year ago and a 2% sequential increase. This decline was primarily driven by the weakness in our European operations. During the fourth quarter, we completed 22 license transactions over $1 million, including one license transaction over $10 million. This compares to 33 license transactions over $1 million and no license transactions over $10 million in the year ago quarter.

As previously discussed, when it comes to service and identity management, which we consider businesses with higher growth potential, we think it’s appropriate to focus on license bookings growth as a leading indicator. For the quarter, service management license bookings were up 4%, and identity management license bookings rose 10%.

Beginning in fiscal 2006, part of our sales force realignment focused on executing shorter length transactions. As a result, a significant number of our customers are entering into contracts of a shorter duration than in the past. To help you better understand the impact of this trend on our business over the past year, we are introducing several new metrics including total bookings, average contract length and annualized total bookings.

Total bookings measure the total contract value, including license, maintenance and services of all the transactions that were executed in a given period. Total bookings are calculated as the sum of total revenues, plus the change in total deferred revenue. The weighted average contract length is defined as the average period of a customer’s contracts executed during the period weighted by the contracts’ value. Annualized total bookings are total bookings for the period, divided by the weighted average contract length of the bookings for that period. Annualized total bookings are another key indicator of the underlying trends in our business activity.

For fiscal 2006, total bookings were $1.48 billion, which is calculated by summing annual revenues of $1.5 billion and the negative $15 million change in total deferred revenue. This was a 12% decline compared to total bookings of $1.69 billion in fiscal 2005. The weighted average contract length in fiscal 2006 declined to 2.3 years from 2.6 years in fiscal 2005. As a result, annualized total bookings for fiscal 2006 were $658 million, which was essentially flat when compared to $656 million in fiscal 2005.

These new metrics are included in slide 9 of our presentation on the web.

As Bob mentioned, our new structure will enable us to better focus and align resources to accelerate growth in our ESM business and maximize value in our MSM business. As we begin reporting on our two business units, we are evaluating the best metrics to provide on an ongoing basis.

Our Enterprise Service Management business unit includes Service Management and Identity Management businesses, as well as our Distributed Systems Data Management, BMC Performance Manager and Transaction Management product lines. The Mainframe Service Management business unit includes the current Mainframe Management business and our enterprise job scheduling and output management product lines.

Turning now to revenues. Total revenues were $408 million, an increase of 3% compared to the fourth quarter of fiscal 2005, and at the top end of our guidance range. Fourth quarter license revenues were $161 million, an increase of 5% compared to a year ago. The percentage of license bookings in the fourth quarter deferred was 42%, which compares to 46% in the fourth quarter of fiscal 2005 and 49% in the third quarter of fiscal 2006.

Maintenance revenues in the fourth quarter of 2006 were $220 million, an increase of 1% compared to a year ago. It is important to understand that maintenance revenues can have quarterly fluctuations based on the timing of contracts, renewal rates and new license bookings. Rather than focus on quarterly swings, we believe that looking at maintenance revenues on a four quarter trailing basis allows for a more meaningful assessment. On a four quarter trailing basis, maintenance revenues of $879 million were up 7%.

Professional Services revenues were $28 million for the fourth quarter, up 10% in comparison to the year-ago period.

Turning now to operating expenses. We are pleased with the success of our cost management efforts that we implemented this year. I would like to point out that during fiscal 2006, we delivered on our commitment to reduce non-GAAP annual operating expenses by $100 million. Largely as a result of these efforts, non-GAAP operating expenses in the fourth quarter declined by 12% to $337 million.

In fiscal 2006, our restructuring activities focused mainly on reducing and aligning costs with revenues and eliminating excess overhead. As we move into fiscal 2007, we continue to believe there are substantial opportunities for us to further enhance operational efficiency.

During 2007, our focus will be on simplifying, standardizing and automating our key business processes. These efforts will be ongoing throughout 2007 and beyond. Currently, we expect to incur $30 million in restructuring expense over the course of the year resulting from these actions.

Moving on to the balance sheet. During the fourth quarter, there were $74 million of gross additions to the deferred license revenue balance. This resulted in a sequential increase in the deferred license revenue balance of $13 million to a record high of $432 million.

Total deferred revenue increased by $54 million in the fourth quarter to a year end balance of $1.63 billion.

Software development costs on the balance sheet decreased by $3 million, as we capitalized $14 million and amortized $17 million.

Cash and marketable securities on the balance sheet increased by $170 million in the fourth quarter and reached an all time high of $1.34 billion at year end.

For the full year, cash flow from operations was $421 million. Adjusted cash flow from operations for fiscal 2006 was $451 million, which excludes $42 million of restructuring payments, $33 million of tax payments related to the repatriation of foreign earnings and the positive impact of $45 million from servicing receipts due to the timing of their collection and remittance to third party financial institutions. See slide 14 for a reconciliation between cash flow from operations and adjusted cash flow from operations.

Financed receivables sold to third-party financial institutions totaled $47 million during the quarter, compared to $83 million in the year ago period. For the full year, the total amount of receivables sold to third-party financial institutions was $161 million versus $247 million for all of 2005.

It is important to note that all the receivables that we sell are on a non-recourse basis and therefore have no residual exposure to BMC after the receivables are sold.

During the fourth quarter, we repurchased approximately 6 million shares for an aggregate value of $125 million. During the fiscal year 2006 we repurchased approximately 21 million shares for a total of $411 million.

Finally, this morning we filed a form 8-k regarding the sale and partial leaseback of our Houston campus. The sale is expected to generate approximately $290 million, net of transaction costs.

With that, I’ll turn the call back over to Bob for his concluding remarks and guidance for the first quarter and FY 2007.

Bob Beauchamp

Thank you Steve. As I discussed, our focus for the year ahead is to continue the positive momentum we are generating as we drive to further build value for shareholders.

Organizing around two business units provides greater focus and accountability toward significant growth in license bookings and operating margin within our ESM business and improved total bookings and cash flow performance within our MSM business.

New product launches will further enhance our leadership position in BSM as demand continues to increase for solutions that link IT to business processes and enable more effective IT management.

Our actions to simplify our business processes will also yield additional operating efficiencies and an improved operating margin.

Moving on to full year fiscal 2007 guidance.

We anticipate revenues will increase in the low to mid single digits.

We expect to achieve a non-GAAP operating margin of 20% for the year.

We expect non-GAAP EPS will be in the range of $1.22 to $1.32, assuming a 28% effective tax rate. Non-GAAP EPS excludes an estimated $0.40 of special items including expenses for amortization of acquired technology and intangibles, share-based compensation and restructuring.

Finally, we expect fiscal 2007 cash flow from operations to range between $400 million to $450 million. We expect adjusted cash flow from operations to be in the range of $475 million to $525 million, compared to an adjusted cash flow from operations of $451 million in fiscal 2006. Fiscal 2007 adjusted cash flow from operations excludes a negative impact of $45 million from servicing receipts due to third-party financing institutions, and $30 million in restructuring payments.

For the first quarter of fiscal 2007, we expect revenues to be in the range of $355 million to $370 million and non-GAAP EPS to be in the $0.22 to $0.27 range. Non-GAAP EPS excludes an estimated $0.12 of special items, including expenses for amortization of acquired technology and intangibles, share-based compensation and restructuring.

We plan to discuss our strategy and roadmap to create shareholder value in more detail at our Annual Investment Community presentation, which we are targeting for September of this year. We will be providing more information on this shortly and hope that you will all be able to attend.

With that, I will turn the call back to the operator for your questions. Operator?

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, if you wish to ask a question at this time, please press star, then one, on your telephone. If you are using a speaker-phone, we ask that you make sure your mute function is turned off to allow your signal to reach our equipment. Once again, it is star, one please. We will pause for just a moment.

From Goldman Sachs, we will go to Sarah Friar.

Sarah Friar - Goldman Sachs

Good afternoon, everyone. Could you just comment on the growth rates in the two segments that you are kind of splitting apart? On the mainframe side, as I look at trailing 12 month books, it is still down about 20% year over year. At what point does that start to plateau, or even see some growth there? Maybe talk about what is impacting that.

Then on the services side, obviously your growth business, but still growing more like mid-single digits. Do you have a sense, can that kick up to be more like high-single digits, or even a double-digit growth rate?

Bob Beauchamp

Okay, the Mainframe Business I think we would like to see it at something better than or the floor around, down 5%. My head of the business unit assures me that he can get it to flat, but we are not counting on that right now. That is not our plan. Our plan is to decline by about 5%.

The Service Management Unit, we are looking at growth in the 6% to 7% range. We think we can do better than that, particularly as BSM picks up, but that is what we are planning for.

Sarah Friar - Goldman Sachs

Okay. Steve, one quick one for you. In terms of the guidance, the EPS guidance, what sort of share repurchase rate are you including in that? Should we expect a further kind of 125 million a quarter for about 0.5 billion for the year?

Steve Solcher

Sarah, I would probably guide you to between 100 million and 150 million a quarter, leaving us a little flexibility within the quarter, but again, if you look over the past year, we did 411. We are probably going to be in the neighborhood of 400 to 600 for the year, depending on what the stock price does over that period of time.

Sarah Friar - Goldman Sachs

Got it, great. Thanks a lot.

Operator

We will now move on to Michael Turits from Prudential Equity Group.