BMC Software Q1 2007 Earnings Conference Call Transcript (BMC)

BMC Software, Inc. (BMC)
Q1 2007 Earnings Conference Call
August 8, 2006 5:00 pm ET

Executives

Bob Beauchamp - Chief Executive Officer
Steve Solcher - Chief Financial Officer
Derrick Vializ - Vice President, Investor Relations

Analysts

Derek Bingham - Goldman Sachs
Kevin Buttigieg - A.G. Edwards
Brad Smith - Piper Jaffray
Richard Petersen - Levin Capital
Jeffrey Constantino - Banc of America Securities
Jun Chang - Prudential Equity Group

Presentation

Operator

Welcome to today’s BMC Software first quarter earnings results conference call. Today’s call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Mr. Derrick Vializ. Please go ahead, sir.

Derrick Vializ

Thank you, operator. I am 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 first quarter performance; provide you with an update on our Business Service Management strategy and our overall progress toward achieving our fiscal 2007 priorities. After that, Steve Solcher, our CFO, will provide additional financial and operational details. Bob will then provide updated guidance for the second quarter and 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 product, 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 earnings 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 and in our GAAP to non-GAAP reconciliation found on our website at bmc.com/investors.

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

Bob Beauchamp

Thank you, Derrick, and welcome, all of you, to our call today.

Our first quarter results get us off to a very good start in the 2007 fiscal year.

We have now met or exceeded guidance for five consecutive quarters. There are several key highlights for the quarter:

• Revenues grew in the mid-single digits and were in the middle of our guidance range;
• In addition to achieving revenue growth, we continued to improve our expense structure, resulting in the company’s highest non-GAAP operating margin since fiscal 2000;
• Non-GAAP EPS exceeded our guidance range;
• We completed the acquisition of Identify Software, which expands our transaction management capabilities and moves us well into the application development and testing buying centers;
• Through the sale and partial leaseback of the Houston campus, we monetized a significant non-core asset;
• We continued to aggressively repurchase shares while maintaining a very strong balance sheet; and
• A record cash position.

All in all, we delivered solid performance in our fiscal first quarter, as we continue to build shareholder value and we are focused on continuing our positive momentum as we move through the year.

One key factor that we believe will drive this momentum is our leadership position in Business Service Management, or BSM. BSM continues to gain traction in our marketplace, as more and more companies understand the benefits of managing IT from a business perspective.

When we announced our vision for BSM in 2003, we were confident that BSM would become as important and essential for enterprise competitiveness as ERP, human resource, CRM and supply chain management systems. Three years later, our vision has been validated. BSM is the ERP for IT, offering a unified, integrated approach for managing IT assets, processes and functions on an enterprise-wide basis.

Why is this important?

Consider what a top IT executive at a major multinational outsourcer told me just this last week: his company estimates the cost for desktop management is allocated 8% for hardware, 12% for software and 80% on IT labor cost. This exemplifies today’s cost structure problem facing IT operations support. Labor costs are a very large part of a company’s total IT spending and the biggest savings opportunity is the automation of IT processes in support of the business. This is BSM.

BSM offers a real solution to more effectively managing these costs. As we have discussed before, leading industry analysts project that firms that implement BSM may save as much as 25% of their overall IT budget.

BSM improves the quality and productivity of the IT organization and the support it offers to business units within a company. A top IT architect at one of the world’s largest IT users was in our briefing center this month and said to me that our BSM vision and architecture is exactly what he has been driving towards for several years.

We hear this story in our briefing center every week at BMC. We are hearing this same feedback from customers every day as we discuss how BSM can help them better manage their IT environment.

We are delivering our vision for BSM to customers now. During the quarter, we continued to earn the trust and win the business of high profile customers in a diverse range of industries in all geographies; Visa, ANZ Bank, Atos Origin, Conoco-Phillips, European Aeronautic Defense and Space Company, Man I.T. Services, and the Land Registry in the U.K. are among those who are putting our BSM solutions to work.

I want to take a minute to discuss our relationship with Visa which, as you probably know, is the world’s largest electronic payments network, with 1.4 billion cards in circulation that generate more than $4 trillion in global sales in more than 160 countries.

Visa has embarked upon an ITIL initiative to standardize on processes to reduce costs and increase IT Service Delivery. Visa currently manages approximately 100 million transactions per day and expects to scale to a projected 160 million transactions per day by 2010. Their objective is to do so without significantly increasing IT costs.

They had been using a variety of enterprise management software products from our largest competitors. Visa recently launched a highly competitive RFP process -- request for proposal -- to standardize on an integrated solution set and invited multiple competitors to compete for their business.

BMC ultimately triumphed based on the strength of our architecture, as well as the proven success of our technology -- which was tested real-time in trial deployments at the customer’s site.

We are pleased with the progress we are making as we continue to innovate and offer new BSM solutions. In the first quarter, we kicked off the broadest BSM solution launch since our initial introduction of BSM, with over 50 new or upgraded product releases rolling out this summer and fall.

These new product releases deliver more BSM value through integrated, customer-driven solutions. They include new foundation technologies and services, such as new BSM Dashboards, BSM workflows and the BMC Atrium Configuration Management Database, or CMDB, version 2.0. This is our second generation, completely federated configuration management database, and it keeps us well ahead of the competition in an area that is attracting a lot of attention among customers. In fact, one of the most-respected industry analyst firms positioned the CMDB as the single hottest topic in all of IT operations today.

Importantly, in addition to new foundation technologies, we also introduced pre-integrated solutions that address our customers’ top IT management concerns. These include a closed-loop client management system, which reduces the configuration, support and compliance costs associated with deploying mass changes across thousands of desktop systems.

They also include proactive service desk capabilities that further reduce the number and impact of business disruptions while also improving efficiency. They include new, integrated solutions for managing the virtualized data center from a BSM perspective, which is also one of the hottest topics in the industry today.

The significance here is not only in what we are delivering, but the pace and scale of our BSM solutions delivery. Our ability to quickly deliver multiple, pre-integrated BSM solutions is not only increasing the value to our customers but also broadening our competitive lead in this area.

We will be showcasing these initiatives and our broad portfolio of solutions at the upcoming BMC UserWorld, which is scheduled for the week of August 28th in San Francisco. This is our largest annual customer event and will bring together customers, partners and BMC resources from around the world.

Projected attendance at this year’s event in San Francisco will more than double from our largest customer event last year, reflecting the increased focus across our customer base on our BSM solutions.

So far I have talked about our vision of BSM, growing customer acceptance of the vision and the steps we are taking to innovate and extend our technology leadership in this space. I will also touch on how we are strengthening our go-to-market capabilities.

On the direct sales side, we have made significant progress in reorienting and retraining our sales people on higher level solution-selling to CIOs and CTOs. We now have more than 1300 trained ITIL certified individuals in sales, presales, and solutions delivery areas of our company.

We are also gaining strength in terms of our partnerships with systems integrators. Last year, our business through systems integrators increased substantially, and with the recent announcements by HP and IBM, we expect to see even more positive results from this key group of partners.

For example, we are working with Accenture to provide clients with a defined full lifecycle IT management solution. We are combining Accenture’s experience in business process design and implementation with our leading technologies. As we have discussed in the past, Accenture Outsourcing is also using our BSM solutions for its global outsourcing centers.

We shared with you last quarter the views of leading industry analysts who believe that BSM has gone mainstream in terms of how companies prioritize their IT spending. Now there is additional evidence from Goldman Sachs, which recently published its IT spending survey. This study surveys 100 IT executives from multinational Fortune 1000 companies with strategic decision-making authority. The survey asked -- which software vendors are gaining or losing share of your IT spending? -- BMC Software, for the first time in the history of this survey, was in the share gainer’s column. It is interesting to note that none of our larger competitors were on the share gainers list.

As we discussed last quarter, one element of this strategy is the continued evolution of our organizational structure. We have created two business units: Enterprise Service Management, or ESM; and Mainframe Service Management, or MSM. These units are now fully formed and they are up and running.

This new structure reflects the reality that each unit is driven by different market and business characteristics, and their performance must be measured to different business objectives.

Our goal for the company is to improve top-line performance and profitability. MSM’s focus is on stabilizing total bookings and maintaining market share and cash flow, while ESM’s focus is on growing license bookings and expanding margins, particularly in our core BSM product lines, Service Management, Transaction Management and Identity Management.

With a solid first quarter behind us, I want to revisit our key priorities and our 4 focus areas for fiscal 2007.

First, accelerate growth in our ESM unit by building on our brand, technology and distribution strengths in order to capture the positive momentum around BSM.

Second, improve the bookings performance of our MSM unit while maintaining its profitability. While the mainframe market is concentrated and mature, it continues to be an attractive market opportunity. We are focused on improving the performance of this unit.

Third, continue our expense management efforts, driving for greater efficiencies within our business processes.

Fourth, continue to build value for shareholders by delivering solid financial results, generating strong cash flow from operations, and continuing our share repurchase program.

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

Steve Solcher

Thanks, Bob. I will begin by highlighting the significant improvements in profitability during the first quarter. Then I will discuss our booking results and take you through revenues and operating expenses. Following that, I will discuss our balance sheet and cash flow from operations.

Non-GAAP operating income increased 56% to $68 million in the first quarter of 2007, compared to a year-ago.

Non-GAAP operating margin was 19%, up 7 percentage points, on a year-over-year basis. This is a great start to the year as we are focused on achieving our full-year operating margin target of 20%.

Non-GAAP diluted EPS was $0.31, up 63% compared to the year-ago period and exceeded the high-end of our guidance range. Please note, non-GAAP EPS reflects an effective tax rate of 27%.

These non-GAAP results reflect diluted shares outstanding in the first quarter of 211 million versus 221 million in the first quarter of fiscal 2006.

GAAP operating income for the first quarter was $19 million, compared to a loss of $23 million in the year-ago period.

GAAP net income and EPS were $31 million, or $0.15, compared to a loss of $41 million, or a loss of $0.19 in the first quarter of fiscal 2006.

As Bob mentioned, we have created two business units -- Enterprise Service Management and Mainframe Service Management.

The Enterprise Service Management, or ESM business unit, includes our Service Management, Identity Management, Distributed Systems Management, and Transaction Management product lines.

The Mainframe Service Management, or MSM business unit, includes Mainframe Management, enterprise job scheduling and output management product lines. Enterprise job scheduling and output management product lines were formerly part of our Distributed Systems Management product line.

With this new structure, we are also providing the relevant metrics for each of our businesses. These new metrics play an important role in how we manage and evaluate our performance, and are important to understanding the underlying trends shaping our business.

We are providing total bookings for the company on a quarterly and a trailing 12-month basis. This will help you identify the longer-term trend. We are also providing the weighted average contract length of bookings for the trailing 12-months.

Finally, we are providing, as we introduced to you last quarter, annualized total bookings on a trailing 12-month basis. This metric is important because it enables you to see bookings performance in relation to contract length.

We believe our Mainframe business is best evaluated on the basis of total and annualized bookings over an extended term, given the impact that a few large transactions can have on any given quarter. Starting this quarter, we are providing total and annualized bookings on a trailing 12-month basis.

We believe that for our ESM business, license bookings are the best measurement of performance. To help you better evaluate the overall performance of our ESM unit, we are providing ESM license bookings for our Distributed Systems Management product line and our core BSM solutions, which include Service Management, Identity Management, and Transaction Management product lines.

Now let me take you through bookings.

Total bookings for the quarter were up 5% compared to a year-ago period to $368 million.

As I mentioned, quarterly bookings can be significantly impacted by a few large transactions. Thus, total bookings on a trailing 12-month basis is a more meaningful metric, as it will enable you to see the longer-term trend.

Annualized total bookings for the past 12 months were up 4% to $689 million compared to the year-ago period.

Total bookings for the 12 months ended June 30, 2006 were $1.5 billion, and the weighted average contract length for the period was 2.2 years. For the 12 months ended June 30, 2005, total bookings were $1.7 billion, and the weighted average contract length for the period was 2.6 years. Please refer to slide 7 in our slide presentation.

We view this trend toward a shorter contract length as a positive. In terms of our MSM business, shorter contract lengths enable us to maintain better pricing discipline when compared with longer-term contracts. This is why we view shorter contract lengths as a positive trend.

As you can see on slide 7, shorter contract lengths partially offset the decline in MSM bookings for the trailing 12 months. This annualized bookings performance is an improvement compared to prior quarters, and we believe that our new business structure will allow us to continue to deliver improved results.

Now let me turn to our Enterprise Service Management business unit. Total Enterprise Service Management license bookings were $53 million in the first quarter of 2007, slightly above the year-ago period. We believe our performance in Enterprise Service Management, excluding the distributed systems management product line, is a good indicator to look at when measuring the success of our Business Service Management strategy.

Core BSM license bookings were up 11% in the first quarter of 2007 compared to the first quarter of 2006. Please see slide 8 of our presentation for historical license bookings for Enterprise Service Management, with and without Distributed Systems Management.

Turning to revenues. Total revenues were $361 million, a 4% increase compared to the first quarter of fiscal 2006 and within our guidance range.

License revenues in the first quarter were $111 million, a decrease of 3% compared to a year ago. This reflects both a decrease in total license bookings and a higher ratable percentage of 39% versus 33% in the year-ago period.

License revenues for our ESM business unit increased 9%.

Maintenance revenues in the first quarter of 2007 were $229 million, an increase of 7% compared to a year ago. This reflects solid growth in both business units.

It is important to understand that maintenance revenues can have quarterly fluctuations based on the timing of contracts, renewal rates and new license bookings. On a four quarter trailing basis, maintenance revenues of $894 million were up 7%.

Professional Services revenues were $21 million, up 3% in comparison to the year-ago period.

Moving on to operating expenses. Excluding restructuring related expenses, amortization of acquired technologies and intangibles, and stock-based compensation, non-GAAP operating expenses declined 4% to $294 million in the first quarter.

While we are pleased with these expense results and the significant progress that we have made to improve our expense structure, we continue to believe there are substantial opportunities for us to further enhance operational efficiency.

In fiscal 2007, our focus will be on simplifying, standardizing and continuing to enhance the automation of our key business processes.

During the first quarter, we incurred approximately $25 million in restructuring expense, all of which is severance related.

Now to the balance sheet:

Total deferred license revenue balance decreased $20 million sequentially to $413 million at the end of the quarter.

Total deferred revenue increased by $6 million sequentially to $1.63 billion at the end of the quarter.

Software development costs on the balance sheet increased by $1 million sequentially, as we capitalized $17 million and amortized $16 million.

Cash and marketable securities increased by $59 million sequentially and reached an all-time high of $1.4 billion.

For the quarter, GAAP cash flow from operations was $56 million. Adjusted cash flow from operations was $129 million. Adjusted cash flow from operations excludes $11 million of restructuring payments, $3 million of tax payments related to last year’s repatriation of foreign earnings, and the positive impact of $59 million from servicing receipts due to the timing of their collection and remittance to third-party financing institutions. See slide 10 for a reconciliation between cash flow from operations and adjusted cash flow from operations.

Financed receivables sold to third-party financing institutions totaled $54 million during the quarter, down slightly compared to the $55 million in the year-ago period. It is important to note that all 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 first quarter, we repurchased approximately 7 million shares for an aggregate value of $150 million. We have $659 million remaining under our current share repurchasing program.

Finally, during the quarter we closed on two significant transactions:

• We acquired Identify Software for $150 million in cash; and
• We also monetized a non-core asset with the sale and partial leaseback of our Houston campus. This transaction generated approximately $292 million of proceeds, net of transaction costs.

With that, I will turn the call back over to Bob for his concluding remarks and guidance for the second quarter and fiscal year 2007.

Bob Beauchamp

Thank you, Steve. To reflect our strong earnings performance in the first quarter, we are raising our non-GAAP earnings per share guidance for the year. We now expect non-GAAP earnings per share will range between $1.28 and $1.38 for fiscal 2007, using an estimated tax rate of 28% for the remainder of the year.

Non-GAAP EPS excludes an estimated $0.44 of special items, including expenses for amortization of acquired technology and intangibles, stock-based compensation and restructuring.

We reiterate our revenue and operating margin goals for fiscal 2007: we estimate revenue growth in the low- to mid-single digits, and we expect to achieve a non-GAAP operating margin of 20%.

We also reiterate our cash flow from operations expectation to be between $400 million and $450 million, and adjusted cash flow from operations to be between $475 million and $525 million. Adjusted cash flow from operations excludes an estimated $45 million negative impact from servicing receipts and $30 million in restructuring costs.

For the second quarter of fiscal 2007:

• We expect revenues to be in the range of $365 million to $380 million; and
• Non-GAAP EPS to be in the $0.27 to $0.32 range, using an estimated tax rate of 28%. Non-GAAP EPS excludes an estimated $0.11 of special items, including expenses for amortization of acquired technology and intangibles, stock-based compensation and restructuring.

Let me close by saying that I am encouraged by the progress we are making. We continue to gain positive momentum in BSM. The creation of our two business units improves our focus. We are driving for growth and improving our cost structure. We are financially strong and we are returning excess cash to shareholders through our significant share repurchase program.

Our goal for the rest of the year is to continue to work in all of these areas in order to build value for our shareholders.

We plan to discuss our strategy and roadmap to create shareholder value in more detail at our Annual Investment Community presentation in New York City during early October. We will be providing you with more information on this shortly and hope that you will be able to attend.

With that, we will now take questions. Operator.

Question-and-Answer Session

Operator

Thank you.

(Operator Instructions)

Our first question will come from Sarah Friar with Goldman Sachs.

Derek Bingham - Goldman Sachs

Hi everyone, this is Derek Bingham on behalf of Sarah. Two quick questions. First, congratulations on the quarter, and also, I am wondering if you could first of all tell us or give us an idea of what the contribution from Identify was in the quarter?

Bob Beauchamp

Steve.

Steve Solcher

Is that a contribution…

Derek Bingham - Goldman Sachs

By revenue.

Steve Solcher

On revenue? You are looking at a percentage point to the growth rate.

Derek Bingham - Goldman Sachs

Okay, and then also would be curious on any color on geographic performance, also particularly on the progress in Europe under new [management].

Bob Beauchamp

Yes, on the geographic performance, I would say that -- I am pleased to say that Asia-Pacific, after almost a decade of having us talk about not going well, it has gone well now for over a year, so I am pleased with Asia-Pacific. Americas did solid, with some less solid performance on the very large customers, although that is not unusual in a Q1, but in terms of just the broad performance across the large number of customers in the Americas, we were pleased.

Europe was still under what we would like to have seen. It has improved, by the way. We are definitely seeing improvement in Europe, but I think we have some more work to do over the next few quarters. Cos Santullo is spending quite a bit of time with a new management team there in Europe working on that. New business unit structure we think will also help that as we kind of set up some governance models and go-to-market models in Europe that will be a little more streamlined, a little more focused.

I think it will take us another quarter or two to get Europe where we like it, but it is improving and it did improve.

Derek Bingham - Goldman Sachs

Perfect. Thank you.

Operator

Moving on, we will go to Kevin Buttigieg with A.G. Edwards.

Kevin Buttigieg - A.G. Edwards

Thank you. On the cost side, it looks like you saw a -- obviously costs were down nicely on a year over year basis. Now, you saw a sequential decrease in employees by a little bit, even though you added the Identify employee base during that period of time.

How should we look at the year-over-year change in cost? How much of that is really driven by the process improvements that you have undertaken? How much of that is really set to come the rest of the year, and how much of it is due to change in the employee base?

Steve Solcher

Kevin, the first piece of your question is, the headcount is down. It was offset by the acquisition of Identify, so that would bring us neutral on that piece. You have not seen the full restructuring efforts. A lot of that is going to be seen throughout the year. Full run-rate, we are looking at net of reinvestment, roughly about $40 million of savings for the full year ’07.

When you include Identify in that, you are going to look at a total cost structure that is slightly down on a year-over-year basis.

Kevin Buttigieg - A.G. Edwards

Okay.

Bob Beauchamp

I would add that in terms of the people impact though, the lion’s share of the people impacted are either gone or have been notified already.

Kevin Buttigieg - A.G. Edwards

Do you see the mainframe contract length beginning to stabilize sort of at a sub-three level? Or do you think that continues to decelerate to a degree?

Steve Solcher

I would think, I would guide you to -- the contract length for that unit would be pretty stable throughout the remainder of the year.

Bob Beauchamp

We like this range for a number of reasons. One is we think that if we extend beyond that, all the customer is trading is discount for time. We think at this rough contract length we are selling, they are buying software to solve a problem as opposed to just buying discounts.

Kevin Buttigieg - A.G. Edwards

Finally, just real quickly, what is your sense of the Hewlett Packard acquisition of Mercury Interactive? Do you think that changes their competitive position?

Bob Beauchamp

It does. I think it changes it, particularly keen for IBM. I actually view this as much more about an IBM-HP war than BMC.

From our perspective, they picked up some very good products in the test and development side of the house, but from where we compete -- which we do not compete with those products -- where we compete with them, it actually presents what I think is an interesting problem for HP.

They now have, if my count is right, three CMDBs, three help desks, and several -- I do not know how many -- end-user response time management tools that are going to have to be reconciled. I think all of that will require problems for them, will require a defocus for them.

I think the Mercury sales force was fairly famous for being a very well-executing sales force. There is nothing, and I, having been in this industry almost my whole life, I can tell you there is nothing as effective as a dedicated sales force selling a small number of products with very few competitors. That is what Mercury had in their core test development space. That will now drop into the giant ocean that is the HP sales force and they will almost certainly, short-term, lose some focus there.

They are positioning it though as a move towards BSM, so we view that as additional BSM validation.

I would just quickly point out that about 30 minutes ago, before we walked into the room here, Forrester published a take about the CMDB in general. One of the lines in here that I like, it says: "Take one of the CMDB products provided essentially for free by the big four ITSM vendors -- IBM, BMC, CA, and HP -- offer options here, although Forrester does not consider the HP Peregrine product to be a full CMDB yet however, IBM, CA, and HP have inferior BSM capabilities because they focus more on IT service process support." So here is one of the top industry analysts in the world writing a paper on this subject, declaring BMC is by default the superior solution.

We see both IBM and HP making moves that are clearly BSM in their marketing, BSM in their focus, but the reality is going to be somewhat different.

Operator

Moving on, we will go to David Rudow with Piper Jaffray.

Brad Smith - Piper Jaffray

Hi, guys, this is Brad Smith for David. Can you guys talk a little bit about what is driving the BSM product expansion across the customer base, maybe touch on some common entry points that customers are focusing on just when they are getting started?

Bob Beauchamp

One of the key drivers is it is very similar, actually, to what was driving ERP. Why do customers buy ERP to begin with? Because they felt out of control in terms of their knowing what their business processes were, they felt out of control in data architecture and design, so that if you wanted to know how many products were in the supply chain, you would get different answers, depending on who you ask. They wanted to have a common, single source of truth for the business.

IT suffers from the exact same problem. IT suffers from server sprawl, software sprawl, availabilities, disconnected from the end-user, so the whole concept behind this is to build an ERP for IT that allows you to automate what today is done manually.

Case in point -- if you want to do configuration and change management, every company today struggles with this, it is one of the hot areas in BSM. Generally, and it is very often say a Wednesday morning at 10:00, every big IT organization will have a change management meeting. They will have 25 people in a room and they will be discussing the change they want to make to say a server environment, or an application or a database. They have to go around the room and ask every person in the room what potential impact could this have that might cause an outage or might cause a loss of productivity.

BSM, implemented properly, eliminates that meeting, or at least reduces it to just a few people looking at reports generated by our products, telling them these are the impacts.

The same thing happens whenever you have an outage. If an outage occurs of a critical system, a “war room” is the term the industry has used for years, is opened. People go into a room, maybe 20 different people -- some from networks, some database, some servers, some applications -- all in a room, each person in the room has come to the meeting with a report designed to say it is not my fault.

BSM, properly implemented with a CMDB, with service-level management implementation, will allow them to determine rapidly this is the business impact of this. This is a high priority. This is root cause, and have the trouble tickets entered automatically, et cetera.

It is about really providing an automated way what today is done very, very random.

I will just quickly add, customers are buying this in what we call workflows. They buy it in pieces. In the ERP and in the framework wars of the '90’s, some customers would adopt the entire thing all at once. We are not seeing that as much as, certainly to the extent that ERP had that happen.

What we are seeing is they buy the vision, they buy the architecture, they standardize on it, but then they buy an individual workflow, such as configuration and change management, or service level management, or service management, or identity management, in what we call a workflow and they will put those in one at a time.

I hope that helped.

Brad Smith - Piper Jaffray

Yes, definitely. Thank you. Then, just quickly, do you have any -- just comments around expectations for customer spending going into the back-half of the year compared to last year?

Bob Beauchamp

Our normal skew, obviously we are moving into -- Q3 and Q4 are our strongest quarters, but I do not have any earth-shaking insights into the seasonal spin. I think we are all looking at the inflation numbers in oil and all those things, although I have not yet heard any customers get jittery on spending as a result of a global economic discussion.

I am keeping my ears open but I have not seen any slowdown coming.

Operator

(Operator Instructions)

Moving on, we will go to Richard Petersen with Levin Capital.

Richard Petersen - Levin Capital

Can you hear me? You consolidated some of the historical revenue and bookings results into the MSM and EDM. Could you give us a little directional guidance, if you would, on some of the product groups underneath that? For instance, scheduling outputs, some of the things you used to provide us.

Secondly, discuss the pricing environment on the mainframe side?

Bob Beauchamp

Let me answer the second part first. The pricing environment on the mainframe side, no significant change in trajectory. We continue to see a grinding competitive market there. I would say, though, that if we look at our mainframe business, the last two quarters, on an annualized basis, we have seen us move away, we have improved the trend on the trailing 12-month trend that we have had.

We have seen two quarters in a row of what we see as improved total bookings in the MSM space, so that is encouraging. It is not dramatic, but it is material.

In terms of your second, or your first question rather, you were asking us to break out what items are in each of the units again?

Richard Petersen - Levin Capital

To the extent that you could, yes.

Bob Beauchamp

You mean give numbers underneath them, or just say what they are again?

Richard Petersen - Levin Capital

Just give numbers underneath them.

Bob Beauchamp

We will give you a little color, but we are not breaking them out. PATROL as an example, had growth in total bookings, which PATROL, because it is a mature product -- the first version, the original versions that are out there, not BPM, but the original PATROL -- is a mature project. It is more about renewals. We had pretty solid renewals, and we actually had growth in total bookings in PATROL.

We also in BPM saw a double-digit number of brand-new, never-had-them-before customers for BMC Performance Manager, which is the new architecture, the new web-based agent-less architecture that replaced PATROL.

We saw in the “PATROL product line” some nice results there. I hope that helps.

Richard Petersen - Levin Capital

Yes, it does. Thank you.

Operator

Moving on, we will go to Jeffrey Constantino with Banc of America Securities.

Jeffrey Constantino - Banc of America Securities

Hey, guys, thanks. It is Jeff Constantino just dialing in for Kirk Martene here. Just one quick one, just on the outlook for gross margins going forward. You guys obviously had a great quarter. It looks like gross margins went down a little more than what we were expecting. You guys obviously did a great job making up for it on the cost side.

I was just curious if you could give us an outlook for gross margins going forward. Do you expect them to hover around the 75.5% level? Or do you think that you will be able to get them back up to the 78% range that we saw over the last couple of quarters? Thank you.

Steve Solcher

I think the gross margin question is really the cost of sales question and what I would say is, they did dip. I would tell you that we are expecting to see improvement in those lines and go back to where they traditionally have been over a period of time.

One of the beauties about separating the two business units is it allows us to get better transparency and focused into each of those units, so I think your takeaway should be that we are focused on all elements, not only the gross margin but all the various functional areas underneath the gross margin line.

Bob Beauchamp

Let me add to that, if I could. It is a little bit of a segue, but I think it is worth mentioning. Sales took the brunt of the changes to the restructuring in Q1. It is obviously the beginning of the fiscal year. Any changes you want to affect for the sales organization you want to get that out of the way, get them stable and get them going.

We hit a double-whammy on our sales force in Q1. One was we had the restructuring effort that was where the sales took their actions right up-front in full force, and then immediately sent them to school. The reason I want to mention that is our -- I just asked our head of sales operations today to size it for me, because I know it is very large. We did more sales training in Q1 of this year than in the previous two years combined. That is just one quarter, in Q1.

We required all of our worldwide pre-sales, sales, and post-sales people to be ITIL certified before they could even come to the product training, which was a three-week event in San Francisco. Not every sales rep was -- not everyone was there for the three weeks, but over a three-week period, and trained event, and we are continuing the sales training.

So the vast majority of the sales training is complete. They are ITIL certified. They did the restructuring and we still delivered pretty solid, top-line numbers. I am encouraged about the top-line opportunity for our company in the next three quarters, now that the sales force is back on the ground and running and educated on how to sell solutions at a higher level than ever before.

Jeffrey Constantino - Banc of America Securities

Great, that is helpful. Thank you.

Bob Beauchamp

You bet. Operator, let’s have one more question.

Operator

Okay, moving on we will go to Michael Turits with Prudential Equity.

Jun Chang - Prudential Equity Group

Hi, this is Jun Chang for Michael. Just a question, I think in the last earnings call, you had given a sense of what you expect the different business segments to do in terms of growth rates. Correct me if I am wrong here, but I think 67% growth in ESM, flat to down 5 in MSM. Are you still sticking to that? How did the quarter perform against that metric?

Bob Beauchamp

For the year, and I would just add, what I just suggested for Q1 on top-line, while I am pleased with it, it needs to improve. But it does not surprise me. In fact, I think it is reasonable the results we had in Q1, given the sales retraining and the restructuring.

The good news is that a year ago when we did our sales changes, we had a lot of account changes. This year, we have had much less in terms of account disruption, where the same people are still on the same accounts. This year the disruption of sales had to do with training and restructuring, so that was behind this.

We still delivered reasonably good top-line numbers. We certainly delivered what we told you we would do on a total basis on revenues, at least. We do believe though that we do need to see that improve in Q2, 3, and 4, and we are encouraged that it will.

We have seen mainframe improve off an historical trend, and we see optimism in the pipeline and in the sales force in terms of sales force productivity going into Q2, 3, and 4.

Jun Chang - Prudential Equity Group

You think the improvement needs to be in the MSM side?

Bob Beauchamp

I think it needs to be in both. I think that we have seen MSM -- remember, our goal for MSM is to improve total bookings, with an eye toward contract length, so we really look at it from an annualized basis. We saw an improvement there in mainframe.

On ESM, we really are focused on licensed bookings in ESM, and improving their operating margins. So we are going to stay focused on those elements of our business as we run them separately.

All right. Operator, with that, I just want to thank everyone for coming. I particularly want to thank the BMC employees who had to go through one of the biggest product launches in the company’s history, be trained on those products, have a sales force go through certification and sales training and product training, have to deal with smarter spending and restructuring, and yet still delivered on a solid Q1, and we are pleased to be able to raise guidance as we go forward for the rest of the year. We look forward to talking to many of you in the next days and weeks, and look forward to talking to you again and hopefully reporting a solid Q2 roughly 90 days from now. Thank you all for joining us.

Operator

That concludes today’s conference. We would like to thank you for your participation.

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