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BMC Software Inc. (NASDAQ:BMC)

F3Q09 Earnings Call

February 4, 2009 5:00 pm ET


Derrick Vializ - Investor Relations

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

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


Michael Turits - Raymond James

Philip Winslow - Credit Suisse

Kevin Buttigieg - Stanford Group

Israel Hernandez– Barclays Capital

Derek Bingham Goldman Sachs

Walter Pritchard - Cowen & Co.

Abhey Lamba – UBS


Good day, everyone and welcome to today’s BMC Software third quarter fiscal year 2009 earnings results conference call. Today’s program is being recorded. At this time I would like to turn things over to Mr. Derrick Vializ.

Derrick Vializ

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 provide an overview of our third quarter performance of our company business units and update you on recent initiatives. 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

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 operational 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

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

Robert E. Beauchamp

Good afternoon to all of you and thank you for joining us on today’s call. I am pleased to report that BMC Software generated another quarter of solid performance in a difficult economic environment. We maintained our sales momentum, we increase revenue, we controlled expenses while making strategic investments in new solutions and our field sales force. And we increased earnings per share and cash flow from operations.

We are track to have a strong fiscal year performance and we are, in fact, raising our EPS estimate for the year. I will discuss this more in a few minutes.

Let me first share with you some key highlights for the quarter. Total bookings rose 10%, adjusting for currency, and 1% as reported, to $457.0 million. ESM license bookings increased 22% on a constant currency basis and 13% as reported. Total revenue increased 8%, adjusted for currency, and by 6% as reported, with growth in all major geographies. Non-GAAP operating margin was 38%, up from 30% in the year-ago period and up 6% sequentially.

I want to point in particular the continued improvement in non-GAAP operating margin for our ESM business, which is up 15% year-over-year and up 13% sequentially. This improvement was due to both higher revenues and lower expenses.

I should also point out that our mainframe business maintained a strong non-GAAP operating margin at 56%.

Non-GAAP diluted EPS rose 19%. Cash flow from operations increased 138% and our balance sheet remains strong with over $1.0 billion in cash and investments.

These are all very good results and they offer an answer to the question we are hearing most often from investors and analysts: What impact is the economy having on your business?

In short, as these numbers show, our answer to that question is the same as it was last quarter: We are not seeing much change in buying behavior at this time in terms of sales being cancelled or pushed out, and we’re also any unusual sector or geography-specific trends for either of our business units.

However, we remain very mindful of the difficult economic conditions that we and our global customer base are navigation. According to most economists, the economic outlook for calendar 2009 is weak at best. The same is true for overall IT spending.

We know that the macro environment will affect all tech companies by varying degrees. However, as our recent results indicate there is ample evidence that we are among the best positioned companies in IT today.

As we have discussed in the past, BMC offers a number of key advantages to customers in these challenges times and over the course of the broader business cycle. Our solutions address customers’ key priorities, particularly in difficult economic environments. Our solutions deliver high return on investment and short pay-back periods.

Our business model and business mix includes a large block of both recurring and multi-year business that provides us with a high level of visibility in terms of our future revenue stream. We sell into a diverse set of industries and geographies and our management team has consistently proven that we can drive increased productivity within our organization.

There is a new study out by McKenzie which drives home my first point. IT today is focused on efficiency but wants to drive value. IT executives want to get a higher return through improving the efficiency and effectiveness of processes, reducing IT costs, and insuring compliance with regulations.

If this sounds familiar, that’s because it is. It’s what business service management is all about, creating a more nimble IT organization that can rapidly respond to new opportunities, enabling companies to simplify, standardize, and automate processes.

When I met with the IT leaders of four of world’s largest financial services organizations last week, the message I heard from them was clear. Despite the economic, financial, and credit issues that large corporations face today, they still have significant transaction volumes and services they deliver to their customers. Although profits are down, their service requirements are not. They continue to turn to BMC for solutions that will automate their operations, improve service levels, and help them implement long-term structural cost improvements.

The conversations that I had with these firms are consistent with the growing list of customer testimonials that show BSM in action. There is an increased need for processed standardization and vendor platform consolidation, as well as automation to effectively reduce IT cost. That is why so many large enterprises are now standardizing on our BSM solutions.

For instance, Mutual of Omaha saved over $4.0 million in critical business applications by reducing customer impact problem tickets by 69% and application downtime by 66% in the first year. Dredsner Kleinwort centralized their planning and budgeting, increase transparency for IT spend, reduced their number of IT cost centers by 90%, an achieved a first year savings of 3.0 million euros. Capgemini reduced server auditing and patching effort from 45 hours per month to one hour and thought diagnostics now takes three minutes on average per server, down from 37 minutes. Intelnet, a leading European provider of integrated IT services, saved $1.4 million in costs and projects a 370% return on its investment in our IT service management solutions.

The growing demand for BSM solutions and our leadership position in BSM are helping to drive the performance of our company. In the third quarter of fiscal 2009 for example, we completed 22 deals worth more than $1.0 million in ESM license bookings. As total ESM license bookings were $133.0 million in the third quarter, 39% of those bookings came from transactions over $1.0 million. The increase in deal size reflects the strategic traction we are gaining with our customers and the improvement in cross selling and multi-product platform sales.

Let’s talk about a few of those deals. A broad array of major governmental organizations around the world continue to choose BMC to help meet their objectives, which require strong, integrated IT management offerings that stretch across both mainframe and distributed systems.

These agencies and ministries continue to choose BMC solutions because they help them achieve their mission with greater speed, integration, precision, and reliability.

We are also pleased with the expanded relationship we formed with Loblaw’s Canada’s largest food distributor. Earlier in the year BMC won the platform battle at Loblaw’s, becoming the standard for IT management. At that time, they purchased our ITSM suite and our Atrium CMDB. In this most recent quarter they purchased our service assurance and service automation suites. Our experience with Loblaw’s demonstrates the strategic importance of winning the platform battle in our accounts.

Our innovative technologies and our strong sales organization are key factors that drive our BSM leadership. During the fiscal fourth quarter we will launch several new solutions across each of our BSM disciplines. For example, new service support capabilities will help our customers significantly reduce their software asset management costs. I also want to not that Forrester and Gartner recognize us as a significant leader in this important space. In fact, Yphise, a major independent European industry analyst research recently ranked BMC first in software asset management.

The fourth quarter will also be an important quarter for us in releasing new technology in the virtualization space. Expanded virtualization solutions in our service automation discipline will help customers meet compliance requirements in a virtualized environment. And in service assurance new analytics will significantly improve performance management of applications in virtualized environments.

Given the confidence we have in the breadth and depth of our BSM product portfolio, we have put more focus on our sales organization, including upgrading sales talent in key positions, providing more comprehensive management and product training, and instituting more rigor and discipline in our sales processes.

In a short period of time we are already seeing positive results as our ESM sales productivity increased this quarter and on a year-to-date basis. Our goal is to continue to improve sales productivity and the overall performance of our sales organization across all regions on a sustained basis.

As we continue to see productivity improvements we will also seek to increase the size of our sales force as part of our strategy to expand our foot print, compete in more deals, build strategic relationships, and gain broader acceptance for our BSM platform, all of which should enhance our ability to drive higher bookings.

Let me transition now to discuss the performance of our mainframe service management unit. Our MSM solutions are critically important to our larger enterprise customers because they help them consistently meet service objectives while lowering their cost of mainframe management and enterprise scheduling.

BMC recently introduced the industry’s most advance performance advisory technology that provides customers with a proactive means to identify and resolve performance problems and to reduce CPU consumption by as much as 85%, while improving service levels and productivity. This new innovative technology gives customers unprecedented efficiency in savings.

New business activity during the quarter for our MSM unit further confirms that we are expanding our footprint within existing customers and that we are also continuing to win competitive replacements. For example, sales for new customers and competitive replacement doubled in the quarter compared to last quarter.

We continued to increase the MSM install base by adding 17 new customers. J.B. Hunt Transport Services, one of the largest transportation logistics companies in North America is a new MSM customer. This was a big win for us as it was a complete mainframe replacement of CA. In addition, 49 of our existing customers added new product or made competitive replacement in favor of our mainframe solutions.

Our existing customer, DAK, one of the top three health insurance companies in Germany, recently established an IT company called Bitmark to service its own IT needs and to look for external business. Like DAK, Bitmark is relying on our entire mainframes solutions portfolio as well as our service assurance offerings to support their computing environment. Bitmark appreciates the integrated approach and technology of our two business units.

During the quarter we also renewed and grew our relationship with Northern Trust Company, Mastercard International, and the Government of Alberta in Canada. Some of this growth was generated by competitive replacements.

So that covers our mainframe business. As I have noted, our continuing success reflects the strategic decisions that we have made, and continue to make, as we deliver on our ESM and MSM strategies. We believe that there are fundamental aspects to our business to made BMC much better positioned than other software providers as well as the broader field of IT vendors.

As we have said, we have three key operating goals for our business. First, while BMC is well positioned in this challenging environment, we will maintain the discipline and how we run our business in order to yield greater business process efficiency to support long-term growth.

Second, we will remain a leader in BSM by maintaining the most robust technology platform, to continue to innovate and service support, assurance, and automation, and to drive integration across our solutions portfolios with our BMC Atrium platform.

And third, we will continue to focus on increasing our customers run rate of spend, broadening our foot print in existing customers and winning competitive replacements while optimizing our profitability and cash flow. We recognize that this is a challenging business environment for our customers around the world. We view this tough environment as an opportunity for BMC to demonstrate the very tangible value that our offerings provide.

We know that CIOs and CFOs demand more than just promises when it comes to justifying the purchases of new software. They demand proof of improved productivity, decreased cost, and enhanced efficiency, and that is what we are providing them.

We also view the current environment as an opportunity to demonstrate to our shareholders our competitive strengths, resilient business model, and disciplined management.

I will talk more about our outlook for fiscal 2009 later on in the call. But first, here’s Steve.

Stephen B. Solcher

First let me start by saying we had a very strong quarter, delivering solid growth in all of our key metrics, despite continuing uncertainty in the global marketplace and the adverse impact from currency movements. As Bob mentioned, we did not see material signs of broader macro weakness on our business this quarter. However, we remain cautious about IT spending during calendar 2009.

During the quarter we were able to deliver top line growth and reduce our cost structure, generating margin expansion of 8% on a year-over-year basis. We were especially pleased with our efforts of significantly expanding our ESM margins while maintaining our MSM margins and remain committed toward our goal of ongoing operating margin improvement.

As we disclosed in December, we took proactive actions in light of this uncertain economic environment to further rationalize our cost structure. We believe these actions will set us up for the right operating structure entering into fiscal year 2010.

With that, let me start off by reviewing our financial results in more detail. In the third quarter, non-GAAP operating income increased by 31%, from $140.0 million to $183.0 million. Non-GAAP operating margin increased 8% from a year ago to 38%. Please refer to Slide 5 for our non-GAAP income statement, which includes segment profitability of our ESM and MSM business units.

Our improved profitability in the third quarter was driven by our ESM business, with its non-GAAP operating income increasing 166% to $82.0 million. In the quarter, ESM’s non-GAAP operating margin increased 15% to 27%. We remain on track to achieve our goal of doubling ESM operating margins for the full fiscal year.

Our ESM business unit’s non-GAAP operating income was $101.0 million, down 7%, and its non-GAAP operating margin was 56%, equal to the year-ago period. Consolidated non-GAAP net earnings for the third quarter were $121.0 million, an increase of 14% over fiscal 2008. Non-GAAP diluted EPS for the period was $0.64, up 19% compared to the year ago period. This reflects a non-GAAP effective tax rate for the quarter of 31%.

These non-GAAP results reflect diluted shares outstand in the third quarter of $188.0 million versus $198.0 million in the year ago period. GAAP operating income in the third quarter was $129.0 million, compared to $107.0 million in the year-ago period. GAAP net income and fully diluted EPS were $84.0 million and $0.45, compared to $84.0 million and $0.42 in the third quarter of fiscal 2008.

Turning now to bookings, Total bookings of $457.0 million were up 1% compared to the year-ago period. On a constant currency basis, total bookings increased 1%. Total bookings on a trailing twelve 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 twelve month basis was 2.0 years versus 2.3 years in the year ago period.

On an annualized basis, trailing twelve month bookings for the third quarter were $931.0 million, up 21% compared to the year ago period. This marks the twelfth consecutive quarter in which we’ve achieved annualized bookings growth on a trailing twelve month basis. It is also worth noting that this growth rate is now double what we achieved in the year ago period. 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 remain the best measure of performance. Total ESM license bookings were $133.0 million in the third quarter, up 13% over the year-ago period. On a constant currency basis, ESM license bookings were up 22%. On a pro forma basis, or if we had included BladeLogic’s results in the year-ago-quarter, total ESM license bookings would have risen 1%. Adjusting for currency, pro forma ESM license bookings would have risen 9%.

Our Service support business had a strong quarter. License bookings for Service support were $76.0 million, up 16%. This growth was driven by the strength and depth of our product offerings and customers realizing the real value that these solutions bring to market.

License bookings for service automation were $24.0 million compared to $10.0 million a year ago. In fiscal 2009, we have seen strong performance from service automation with pro forma license bookings growth of 47% for the nine-month period. Our outlook for this business is positive.

Service assurance license bookings were $33.0 million, down 21%. Similar to our MSM business unit, service assurance is heavily dependent on renewal opportunities. In this quarter, we had a relatively low number of renewal opportunities which contributed to this decline. In the future, we continue to expect to see fluctuations on a quarterly basis. Year-to-date, service assurance license bookings are down 2%. Please see Slide 9 of our presentation for license bookings trends.

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 third quarter, total MSM bookings on a trailing twelve-month basis were $739.0 million with an average contract length of 2.8 years. In the year-ago period, total MSM bookings on a trailing twelve-month basis were $769.0 million with an average contract length of 3.1 years.

Throughout fiscal 2009, we have seen a decrease in the weighted average contract length on a trailing twelve-month basis. The decrease in total bookings and in contract length is mainly due to where we are in the renewal cycle. There are fewer, large, multi-year deals which tend to have longer contract lengths renewing this year compared to last year.

After normalizing for contract length, total annualized MSM bookings for the trailing twelve months were $266.0 million, up 8% compared to a year ago. We remain pleased with the solid performance and trends we have seen in our MSM business over the last calendar year. However, as we’ve often said, this is a lumpy business in which total bookings can vary from quarter-to-quarter

Turning to revenue, total revenue for the quarter was $488.0 million, a 6% increase compared to the fiscal 2008 third quarter. On a constant currency basis, revenue grew 8%. We expect currency to negatively impact revenue growth for the remainder of the fiscal year.

License revenue was $193.0 million, an increase of 6% compared to a year ago and an increase of 9% on a constant currency basis.

ESM license revenue was $127.0 million, up 24%. MSM license revenue was $66.0 million, down 17% from last year. Maintenance revenue in the third quarter of fiscal 2009 was $256.0 million, up 4% compared to a year ago. ESM maintenance revenue was $140.0 million, up 7% and MSM maintenance revenue was $116.0 million, up 1% compared to the third quarter of fiscal 2008.

Professional services revenue, which is included in the ESM segment, was $40.0 million in the third quarter, up 27% compared to $31.0 million in the year-ago period. Our professional services non-GAAP gross margin increased to a profit of $4.0 million versus a loss of $2.0 million a year ago.

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

Moving next to operating expenses. During the quarter, we saw the positive effect of our continued focus on controlling costs. Non-GAAP operating expenses were $305.0 million, down 4% from the prior year.

Looking at our business units, ESM’s non-GAAP operating expenses were $225.0 million, compared to $234.0 million in the year-ago quarter. MSM’s non-GAAP operating expenses were $81.0 million compared to $85.0 million in the year-ago quarter.

Over the last few years, we have instilled in our business a strong operating and financial discipline, which has enabled us to control expenses and improve operating margins.

Now to the balance sheet. Total deferred license revenue at the end of the third quarter was $584.0 million, representing an increase of $18.0 million sequentially and an all time high.

During the quarter, we deferred $103.0 million of license revenue, or 49% of license bookings, and recorded $83.0 million of deferred license revenue from the balance sheet.

At the end of the third quarter, total deferred revenue was $1.73 billion, a decrease of $32 million sequentially. This decline is largely due to normal seasonality and the adverse impact from currency movements.

Current deferred revenue is now 54% of total deferred revenue, up from 51% a year ago. This increase in current deferred reflects the growth of our ESM business as a percentage of total bookings and revenue.

Our ESM business is generally characterized by greater upfront revenue recognition of new contracts and shorter contract lengths.

Software development costs on the balance sheet were $122.0 million, as we capitalized $25.0 million and amortized $15.0 million during the quarter. Capitalization was influenced by the activity of several major releases in our ESM unit scheduled for general release during the fourth quarter.

Other income in the third quarter was adversely impacted by an $8.0 million write down of the carrying value of certain non marketable cost-basis equity investments. The remaining carrying value of these investments is $10.0 million.

Cash and marketable securities at December 31, 2008, were $1.04 billion. Our net cash position was $723.0 million.

For the quarter, cash flow from operations was $155.0 million, compared to $65.0 million in the prior year.

During the quarter, we repurchased 3.2 million shares for an aggregate value of $80.0 million. We now have approximately $395.0 million remaining in our existing repurchase program. Given the current environment, we anticipate repurchasing approximately $50.0 million of our stock during the fourth quarter.

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

Robert E. Beauchamp

Let me now update you on our current outlook for the full year fiscal 2009.

We are raising our expectation for full fiscal year non-GAAP earnings per share. We now expect non-GAAP earnings per share in the range of $2.20 to $2.30 per share for the fiscal year 2009.

We are maintaining our expectation for total bookings growth and total revenue growth for fiscal year 2009. We expect our total bookings growth for the current fiscal year to remain in the mid-single digits and our total revenue growth to remain in the high-single digits. We do expect an adverse currency impact on our top line in the fourth quarter, and the scope of the impact should be higher than it was in the third quarter.

We now expect full year fiscal 2009 cash flow from operations to be between $600.0 million and $630.0 million. We adjusted the high end of our cash flow range to reflect the greater impact from currency movements and higher cash taxes.

Our non-GAAP EPS range excludes an estimated $1.00 of special items including expenses related to amortization of acquired technology and intangibles, stock-based compensation and restructuring activity.

The assumptions underlying these full year fiscal 2009 estimates include a license bookings ratable rate flat in comparison to the prior year, a non-GAAP operating margin of 33% for the year, 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 for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Michael Turits - Raymond James.

Michael Turits - Raymond James

On mainframe, I understand how bookings would be down if there is less renewal opportunity, but I would have thought that the mainframe license revenues would have been smoother. It looks like it was down the same amount. So why didn’t we see that down a smaller degree?

Stephen B. Solcher

On the license side I think it’s a direct correlation between the license bookings decline for the mainframe unit, which was down 17% in the quarter. Again, the license revenue number was down a corresponding percentage.

Michael Turits - Raymond James

My thought would have been that some of your license revenue ought to be on a term basis, I was expecting that to be smoother. Don’t generally you think of those as correlating?

Stephen B. Solcher

We do see more of our revenue comes off the balance sheet on the mainframe side but we still have to go get current period revenue so it will have an impact, and I think it’s directly correlated. We didn’t see a big move in the deferral rate for the mainframe side so it’s directly, in my mind, correlated with the lack of license bookings on that side.

Robert E. Beauchamp

And that’s primarily associated with the term length shortening somewhat. If you adjust for the average term length reducing we are pretty pleased with what we saw off the mainframe this quarter.

Michael Turits - Raymond James

On expenses, obviously you were first [inaudible] on margins, opex was down $13.0 million sequentially on a non-GAAP basis. Of that sequential $13.0 million drop in opex, how much of that was from currency? And especially with ESM margins, I think you said being 28%, how much more room to go in terms of margin expansion does BMC have, especially if that’s now going to be 33% for the year?

Stephen B. Solcher

I think on the currency side on expense, the vast majority of the decline on expense was currency but I think it’s fair to put in the Blade number in the year-ago period. So I kind of say that that normalized itself. So whatever pro forma expense would have been in the previous period, that had an offsetting amount from currency. So our true expense is down 4%.

And how much further it can go, I think we said 33% margins but if you look at ESM for the full year, we are only talking about doubling that from 8% the year before so we are looking at 16%, 17% ESM margins, and I think there’s a way to go on the ESM side.

Robert E. Beauchamp

The one thing I will add to that is that these margins are good margins. And it does give us the ability, now that we’re say at a higher altitude as a company, from a margin basis, to spend a little money smartly and that’s why we are going to invest in our sales force; we are going to add more sales people, increase headcount in sales, more customer-facing people. We’ve got some investments we’re making in some really exciting new innovative technologies that we have identified.

You will see some great announcements from us this quarter as we come out with a set of new products. So I think the fact that we’re such a strong company financially is really a great place to be in this tough economy because it gives us a little bit of altitude, a little room, to invest to try to take market share and to innovate faster than the competition.

Michael Turits - Raymond James

Congratulations on the Remedy bouncing back. Anything that particularly drove that?

Robert E. Beauchamp

No, it was just what we said last quarter. We knew last quarter was not a trend, that it was simply an element of sales focus and all of our businesses are a little bit lumpy and we kind of over-performed in another unit, underperformed in Remedy. That came back the other way. You know, these sign waves don’t move in straight lines and we are fine with all of our businesses and how they are vectoring right now.


Your next question comes from Philip Winslow - Credit Suisse.

Philip Winslow - Credit Suisse

Just wanted to get your perspective sort of across your portfolio, mainframe versus distributed. As you look going forward here, obviously you have been having some benefit from just the Z-10 launch but as we are continuing in an uncertain economic environment, where do you see the relative strength coming from? And also, how does BladeLogic, in particular, play into that?

Robert E. Beauchamp

Mainframe, when times get tough what customers are really focused on is efficiency. They really are looking how to drive cost out right now. They’re not looking for a lot of shiny new objects. They are trying to say how to get costs down right now. And so we see the mainframe renewals as strong as it’s been in years.

In fact, I just was in Switzerland last week and visited with the head of mainframe for one of the largest mainframe users in the world and he informed me that they were actually removing workload back to the mainframe as a way to reduce costs. And that they saw our technologies as key to driving costs down in that environment.

So I think mainframe is particularly well positioned in tough economic cycles. It’s not bleeding edge, it’s not a new project. It is running the business and people are really focused on running the business more efficiently.

In terms of Blade, Blade is just red hot. I don’t know how else you would describe it. It’s hot from all aspects of all industries, all verticals. I just looked at a list a few minutes ago that showed about a dozen or so major wins we had against Opswear, head-to-head where really, almost all the ones we were tracking. So it’s just a red hot product, it’s helping customers automate very labor-intensive parts of their business and increase availability. So it is a great technology in that space.

ESM is much less exposed to financial services than MSM. ESM I think is probably only in the neighborhood of about 10% of the revenue this quarter was in the financial services, so it’s a very diversified portfolio to begin with. So we are seeing strength in that.

You saw very strong numbers in service support. It shows kind of a broad base acceptance across multiple industries. You saw our press releases recently on defense and telcos. Telstra was a major standardization, one we just had. So that is helping drive, platform standardization is also a part of it. And we think Remedy and Blade and our mainframe business are all key parts to that.


Your next question comes from Kevin Buttigieg - Stanford Group.

Kevin Buttigieg - Stanford Group

I wanted to talk about the operating cash flows for a minute. Your guidance for this fiscal year looks for about 4% year-over-year growth at the midpoint and I was wondering if you could break out the impact on that number that you are seeing in terms of currency, in terms of the tax impact, as well as in terms of the sold receivables. Is there a way that you can kind of gauge what the aggregate impact and potentially the contribution of each of those items is to your operating cash flows this year, positive negative.

Stephen B. Solcher

Let me try to do that. We are going to get some benefit from FX into cash flow this year. it primarily relates to the benefit that we got earlier in the year, the calendar year. so if you think about the lag effect that you have on the booking side, we had a tailwind at the first half. We’re actually going into a headwind now. So we will get a little bit of pickup on cash flow on that side.

On the monetization side we’re actually seeing much less monetizations this fiscal year than we did the year before. So we’re tracking right now to right now to a full year number that’s roughly $140.0 million. Last year we did about $270.0 million, so again, I always caution people to look at that as a trend because when we think about our business we think about it both the trade and the finance side as being one piece. The PSOs are relatively healthy.

When I look at the composition of cash flow this year, what you’re seeing is you’re seeing more of our cash flow come from what I deem as cash earnings, as less working capital management. And the key driver of that working capital management is is we’re not out doing these long, multi-year deals and collecting that cash up front. So composition-wise, much better.

And then final piece, you were talking about cash taxes. We are estimating to pay about $30.0 million in cash taxes this year than we did last year.

Kevin Buttigieg - Stanford Group

In terms of operating margins, obviously you had out-performance this quarter. Could you provide an update to your long-term outlook for operating margins and define long-term however you would like. In light of the out-performance this quarter and then in light of Bob’s comments with regards to investments being made in the sales capacity side there.

Stephen B. Solcher

I’m a little hesitant to give you any kind of view into next year, other than I think it is fair to expect us to continue to be very focused on the margin and to constantly be looking to improve that number. I think the rate and pace of that improvement is something that we internally are looking at constantly and I think you are going to see about a 500 basis point increase in 2009 and I would just say we are looking at a much less rate and pace of that increase. 10 and 11 will be dependent on the broader macro trends.

Kevin Buttigieg - Stanford Group

Currency obviously impacted total booking negatively by about 9% this quarter. How did that compare versus your expectations this quarter?

Stephen B. Solcher

Currency was actually worse than we were anticipating. Roughly about $10.0 million in total bookings which was why, at least on the top end of cash flow, why we took the range down.

So again, a little bit of hurt, and we’re expecting even more hurt when you think about it going into the fourth quarter.


Your next question comes from Israel Hernandez– Barclays Capital.

Israel Hernandez– Barclays Capital

Around the mainframe business, did you see any accelerated renewals on contracts that are coming up over the next several quarters, due to the macro? And second, how should we be looking at the mainframe renewal cycle heading into fiscal 2010? I know we’re coming through a trough here but are we looking at a maintenance renewal cycle that picks up in the first half or more towards the second half of fiscal 2010?

Robert E. Beauchamp

On the acceleration it is actually the opposite. We actually saw somewhat of a lower percentage than usual in terms of deals that we had early renewals on. We think that was a sign of strength. Our prices held, our discounts have held very well. In some negotiations were able to tell the customers, given our strength, to just wait. They would offer the bene, they would offer it up to do the transaction early for better discounts, and we said no. We think it maintains integrity to our pricing structure.

You are also not seeing us do a lot of very long deals. You’re not seeing our average term length really expand like you are seeing out there with some of our competitors. We look at that at interpret that potentially as a discounting maneuver and we are not having that in our business. We think we are winning our deals straight up, gaining span, gaining market share, in the mainframe space and holding the value in the deals.

In answer to your second question, it is more of a second half phenomenon but as we look at it, it is quite clear that we do have a good solid renewal trend coming next year, in the second half of next year.


Your next question comes from Derek Bingham Goldman Sachs.

Derek Bingham Goldman Sachs

On uses of cash, you had mentioned your expectations for a buy back, which is appreciated. How about M&A. There might be a kind of increasing volume of opportunities out there, given what’s happened in the marketplace. How are you thinking about that right now?

And as part of that, does the amount of cash overseas versus what’s in the U.S. come into play in terms of how you are planning on using your cash this year?

Robert E. Beauchamp

On the M&A, our answer to that really hasn’t changed since the last conference call. It is fair to say we are more cautious right now in doing acquisitions. It’s like buying a lot of things, is now the time to buy, are prices going to continue to come down? We see some of the smaller companies under duress and other companies are under duress and so we think that prices may have room to improve on some of these other assets out there that we might be interest in.

So we are going to be more cautious, we are being more financial in how we look at it to make sure that the numbers work. But we will continue to look at acquisition as a way to help drive the evolution of the company, when it makes sense. I think it is fair to say we are a little more cautious that we have been in previous years but about the same as we have been in the last couple of quarters.

Stephen B. Solcher

And the on-shore/off-shore distribution of cash, we have about two-thirds on shore and about one-third off shore. And I think it’s safe to say that one of the uses of that off-shore cash has always been for us, when we think about M&A, is to be able to use that for any kind of foreign M&A.

Robert E. Beauchamp

I would add one more thing to that. The remove on the share buyback, it was not directly related to a transaction. There is no pending transaction that had us move to that. It was just the right strategy at this time in this economy.

Derek Bingham Goldman Sachs

Did you mention the FX impact that you’re expecting currently for fourth quarter? It’s kind of implicit in your guidance for year-over-year revenue growth.

Robert E. Beauchamp

For revenue? Is that what you’re asking?

Derek Bingham Goldman Sachs

Yes. And bookings, too. Since bookings had such a big delta in this quarter.

Stephen B. Solcher

We had about two points to the revenue number. I would say that would more than double in the fourth quarter. And then for bookings, we’re looking for that also increasing, probably greater than the 9 points that we saw this period. It’s probably more around 11 our 12 points.


Your next question comes from Walter Pritchard - Cowen & Co..

Walter Pritchard - Cowen & Co.

On the mainframe side, it sound like you’re able to hold the line on pricing. Is there any sign that capacity trends for customers looking forward are changing as a result of what you are seeing in the economy thus far?

Robert E. Beauchamp

I don’t think I’ve got any real break-through facts on that. It appears to me that customers are continuing—I will tell you what a customer said to me who was the head of all IT for one of the largest banks in New York. He said just because their trading is less profitable, it doesn’t mean the volume has gone down. And in fact, in some of their key businesses, the volume has actually gone up.

So we are seeing, they do have to invest in it. I would point to the fact that out of our top 15 deals in mainframe last quarter, the annual run rate went up on average 28%. So we are actually having customers sign up for 28% more than they did with us, that same customer, prior to the contract. So we are seeing customers sign up for more business with us. It’s not just capacity. As a matter of fact I would say it’s more increased footprint.

Walter Pritchard - Cowen & Co.

And related to that, I think during the last downturn you were quite concerned when IBM did a little bit of consolidated, bought Candle, that you would see some pricing pressure. And they haven’t made any acquisitions but I’m just wondering in general what are you seeing out of IBM on mainframe software pricing side.

Robert E. Beauchamp



Your next question comes from Abhey Lamba – UBS.

Abhey Lamba – UBS

I just want to understand more about the drivers behind your margins this quarter. On an absolute dollar basis your expenses declined in every category, even on a year-over-year basis. And this probably does not include the impact from recent lay-offs. Number one, is that true? And number two is can you grow revenues with a further decline in expenses and how much room do you have before you need to start growing expenses again?

Stephen B. Solcher

Let me answer the first question first and that is what you have not seen, which is something that I’m glad that you highlighted, is we have not seen any reduction in expense due to the December action. I would you to caution to think that there is going to be a lot of expense reduction in Q4. I think you are going to see the majority of that reduction occur starting in next fiscal year just because of the timing of some of these schedules terminations. So I think the first question is is that we haven’t seen what I would say is the reduction from these actions.

The second piece, the second question, I’m not too sure that Bob and I are looking for expense reduction as much as we are as can we grow with holding the expenses in line, or reapportioning expense. As we have said earlier, we are investing in the field and customer-facing opportunities and we are investing in our development organization because I think that will position us well as we go into fiscal year 2010.

So at this point in time the goal is not to reduce expense dramatically, it’s really to think that we have the right cost structure in line.

Abhey Lamba – UBS

And do you feel you have the right cost structure in line to grow revenues in fiscal 2010?

Stephen B. Solcher

I do. Again, there are a lot of things that change in the future but I think we believe that we have got the right operating model today, that we can grow not only the top line, but hold expenses pretty much constant and still have margin expansion and do all the right things that will position us well as we exit the broader macro.

Robert E. Beauchamp

But let me add one point. I still think that we have a long way to go before I can say that we are running maximally efficient. I still think we waste money, we still have some inefficient processes ourselves, and we are really constantly focused on running a meaner, leaner organization so that we can spend more money on our customers and more money on our customer-facing employees. We still are not best-in-class across every functional area of the company and our goal is to be really, truly best-in-class on our expense to revenue ratios across every department of the company and we’re not there yet.

Abhey Lamba – UBS

The FX expected impact on expenses in the fourth quarter?

Stephen B. Solcher

I think it’s going to be a benefit. I just don’t have it in front of me. It’s probably going to be slightly greater than where we were in Q3. My estimate right now is probably going to be a net hurt. Somewhere in the neighborhood, my gut would be somewhere between $15.0 million and $20.0 million of help.


There are no further questions in the queue.

Robert E. Beauchamp

Let me just thank you all again for joining us. Let me leave you with one little short story. Last week I had the opportunity to be on CNBC on Power Lunch, an interview, and George Colony, who is the CEO for Forrester Research, one of the most quoted companies, obviously, in technology and George was asked about tech spending. And his answer was, “Tech spending we think will be down about 3% in dollars and up 3% in local currency. It’s going to be a tough year in tech, no doubt about it. Bob’s business being enterprise, the best business will be in software and services, then declining in communications hardware. The worst decline will be in PCs and servers.” And his last sentence was, “But Bob’s actually in the best shape.”

I believe that is absolutely the case. I believe we are a company that sells efficiency; we sell cost savings into an enterprise environment that is incredibly focused on cost savings through process simplification and automation and that is really all we do at BMC. So we do think that we are in excellent shape on a relative basis, we do think the economy is difficult and we are planning for that but we are excited about the future and our ability to innovate and to grow, even in this environment.


This concludes today’s conference call.

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