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Executives

Derrick Vializ - Investor Relations

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

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

Analysts

Brian Denyeau - Oppenheimer & Company

Israel Hernandez - Barclays Capital

Derek Bingham - Goldman Sachs

Kevin Buttigieg - FTN Equity Capital Markets

Michael Turits - Raymond James

Walter Pritchard - Cowen & Company

Richard Sherman - MKM Partners

BMC Software, Inc. (BMC) F1Q10 Earnings Call August 4, 2009 5:00 PM ET

Operator

Good day, everyone and welcome to today’s BMC Software first quarter fiscal year 2010 earnings results conference call. Today’s program is being recorded. At this time for opening remarks and introductions, I would like to turn the program over to Mr. Derrick Vializ. Please go ahead, sir.

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 first quarter financial and business performance. After that, Stephen Solcher, our CFO, will provide additional financial and operational details. Bob will then provide an update on our expectations for fiscal 2010 before we open the call to questions.

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

Before we continue, I would like to remind you that 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 and acquisitions strategies 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, the financial presentation, and in our annual report on Form 10-K. All of these documents are available on our website.

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

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

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

Robert E. Beauchamp

Thanks, Derrick. Good afternoon, everyone, and thank you for joining us on today’s call. In what continues to be a difficult operating environment, BMC performed relatively well during the first quarter of fiscal 2010. We achieved solid results across most of our key financial metrics, including revenue, non-GAAP operating expenses, non-GAAP operating margin, cash flow from operations and non-GAAP earnings per share.

We remain on track to achieve or exceed all of our key financial goals in fiscal 2010, and are in fact raising our non-GAAP EPS guidance for the year.

Let me share some highlights for the quarter -- total revenue grew 3%, and by 6% on a constant currency basis; non-GAAP operating expenses were down 7%; non-GAAP operating margin was 33%, up 8 percentage points from 25% in the year-ago period; ESM non-GAAP operating income more than doubled year-over-year to $43 million; non-GAAP EPS was $0.59, up 37%; GAAP EPS was $0.44 compared to $0.01 a year ago; cash flow from operations was $155 million, an increase of 3% or 23% on a constant currency basis; our balance sheet remains strong, with $1.3 billion in cash and investments and $1.7 billion in deferred revenues.

While I am pleased with our strong performance across most of our financial metrics, the one area that was weaker than we anticipated was bookings. Given the difficult comparison and the timing of mainframe renewals, we did expect bookings to decline year-over year. However, the decline was more than we anticipated. Total bookings in the first quarter were $390 million, down 19% as reported and 15% on a constant currency basis.

The bookings shortfall was driven by several factors. One was clearly the economic downturn. Multiple industry analysts and a number of Wall Street firms have noted, IT spending contracted in the first half of calendar 2009 and was weaker than expected, particularly in the April-June quarter. We, like other enterprise software companies, felt this downturn. We saw it across all major geographic regions and most acutely in Europe.

Another factor affecting bookings was the reduction in closure rates of larger and more complex transactions that we experienced during the quarter. This is related to economic conditions, as the macro environment has elongated sales cycles in our ESM business and to a lesser extent our MSM business. More so than in past periods, we have observed that larger transactions are receiving significantly more scrutiny and requiring additional levels of approval. This is resulting in a lengthening of approval cycles on a global basis and delayed transactions. In fact, for ESM we already closed the largest of the delayed first quarter transactions, and are actively working with customers on closing the remainder. It is important to note that we saw no change in our competitive position during the quarter.

Our ESM bookings performance was also affected in the short term by the recent transition we have made to a new ESM sales strategy. As has been mentioned previously, we have significantly transformed our sales process and culture to drive a more aggressive and productive sales organization. While this change did have some impact on first quarter bookings, we firmly believe that the combination of our industry-leading product portfolio along with the industry’s best sales organization provides BMC a truly fundamental competitive advantage for the long term.

As part of this transition to a new sales organization we made significant changes to our sales personnel. We are firmly committed to our sales strategy and believe the new sales organization will clearly demonstrate its effectiveness in the coming quarters.

Another factor affecting bookings is the lumpiness inherent in our MSM business. As bookings for our MSM business are tied largely to the timing and size of renewals, MSM bookings can be lumpy from quarter to quarter. For example, MSM bookings last year were strong although they significantly varied from quarter to quarter.

So that gives you an overview of what our first quarter bookings were all about. While we are not pleased with our bookings results in the first quarter, we see no fundamental change in the health of our markets, end-user demand, our business strategy or our competitive positioning. We continue to see strong interest in our BSM solutions and our win rate against the competition remains high. The promise and potential of our markets and business model remain quite strong.

As I discussed during our recent Investor Day, BMC caters to the growing needs of enterprises and their CIOs. We enable companies to link IT strategies with business strategies, reduce IT costs, improve IT governance and make IT process improvements. And we do it by offering an IT management platform that is more robust, better integrated and technically superior to our competition.

During the first quarter, we had a number of examples of leading companies around the world moving to standardize on our complete BSM platform: Baxter Healthcare, a leading global, diversified healthcare company, needed to get a better grasp on its IT assets to provide transparency back to its business. Therefore, Baxter made a major additional investment in our IT Service Management, or ITSM, Suite to build a foundation that will enable them to better understand the cost and performance of its critical applications.

As an outsourcer, OBS France Telecom, one of the largest telecommunications companies in the world, needed to improve their competitiveness in terms of marketing their services. As a result, France Telecom decided to add our Service Automation and Service Assurance solutions to their existing BSM portfolio.

Pacific Gas and Electric Company, or PG&E, one of the largest natural gas and electric utilities in the U.S., added our Service Support and Service Assurance solutions in order to move toward a complete standardization of our BSM platform.

Telefonica, one of the largest fixed-line and mobile telecommunications companies in the world, was looking to reduce costs, optimize availability and improve the quality of their services in Latin America. Telefonica selected our Service Management solution to help them implement ITIL. The solution is already implemented in Telefonica Data Brasil and in Telefónica Moviles de Argentina.

The benefits of a consolidated platform approach for managing IT from a business perspective for these customers is easily cost-justified even in these difficult times. They see BMC as a trusted supplier and integral to supporting the attainment of their goals.

One of the keys to our strategy – and ultimately to our success – is our continued investment in technology that enhances our leadership position. Enterprises today are extending their service-enabled, highly virtualized and highly automated environments to cloud infrastructure services. To help customers meet this need, BMC teamed up with Amazon Elastic Compute Cloud, Amazon EC2, to deliver a unified approach to IT planning, control, compliance, automation, and management for cloud environments.

The enhancements we continue to make to our BSM platform are receiving considerable industry attention. In June, we received the CIO 100 award, presented by CIO magazine, recognizing our Closed Loop Asset Management process, which automates the request, provisioning and decommissioning of server and storage resources to individual development projects. The vast majority of CIO 100 honorees are BMC customers. It’s gratifying to see our customers recognized for the business achievements they have realized through the use of our information technology.

In addition, due to the success of our Event and Impact Management solutions, we were positioned in the Leaders Quadrant of Gartner’s recent report “Magic Quadrant for IT Event Correlation and Analysis,” which evaluates vendors’ abilities to execute and their completeness of vision. We believe our placement in this area demonstrates the competitive strength of our Service Assurance technology.

As you all know, recently we teamed up with Cisco to strengthen our presence in next generation data centers and in the heart of virtualized environments. This collaboration enables us to deliver a major breakthrough in management and automation for the new Cisco Unified Computing System.

I am happy to note that Cisco had their first UCS shipments in July and BMC’s BladeLogic for UCS was included in their first official customer orders.

Turning now to our MSM unit, we continue to expect that fiscal 2010 will be a solid year. Our MSM solutions are essential to helping our larger enterprise customers by enabling them meet business objectives while lowering their cost of mainframe management and enterprise scheduling.

The decrease in first quarter MSM bookings is due largely to the traditional lumpy nature of the business. It is important to note that we did not see any material change in term length or any material change in discounting. We continue to expect a robust renewal cycle as we move through the year and we continue to execute well to drive new business.

During the quarter, we once again increased the MSM installed base by adding 13 new customers and 36 new product placements in existing customers, and nearly doubled total bookings from new products from the year-ago period. Some of these customers include Banco do Brasil, United Healthcare, the Social Security Administration and Fidelity Investments.

As further evidence of our strong position in the mainframe market, we once again grew the annual run rate of our top 15 MSM transactions. This is the ninth consecutive quarter where we have seen an increase in this key measure of business health.

Looking forward, we expect to see a strengthening of the mainframe renewal cycle beginning in the second half of fiscal 2010 and continuing into fiscal 2011. Given the economic environment, we are naturally cautious about the outlook for IT spending overall and we will be monitoring conditions closely to see how this impacts the mainframe market so that we can respond appropriately.

To sum up, we intend to meet or exceed the fiscal 2010 expectations that we originally outlined in May and that we reiterated at our Investor Day in June. In the short term, the economic environment is elongating the sales cycle. This, coupled with a lumpy mainframe business, had an adverse affect on our first quarter bookings.

Our markets, customer base, strategy, partnerships, competitive position, financial position and technology remain strong. We will continue to leverage these strengths to deliver value for shareholders over the long-term.

I’ll talk more about our current outlook for fiscal 2010 later in the call. But first Steve Solcher, will provide more insight into our financial results.

Stephen B. Solcher

Thanks, Bob. I would like to start out by offering some additional perspective on our first quarter performance. Then I will take you through the income statement, bookings, cash flow and the balance sheet.

The first point I would like to make relates to the operating discipline we have instilled in our business. As our results demonstrate, we continue to make solid progress in building a resilient business model with significant operating leverage. During the quarter we grew revenue, reduced expenses, improved profitability and generated solid cash flow from operations.

Our business model benefits us in both good and difficult economic times. In periods of growth, we are able to deliver a substantial portion of each dollar of incremental revenue to the bottom line. We’ve seen this unfold now for a number of quarters. These improvements we have made are real, they are sustainable, and there is more to come.

Our business model also provides a critical advantage to us in more difficult times. It affords us the flexibility needed to appropriately align operating expenses with revenue and bookings trends. We will continue to closely monitor underlying market conditions and their impact on our business. As we remain focused on achieving our profitability and cash flow goals.

As I go through our performance during the first quarter, I will refer to some of our growth measures on a constant currency basis, as volatility in the global currency markets--primarily currency movements against the dollar--continues to impact our financial results.

With that, let me turn to our financial results for the quarter.

In the first quarter, non-GAAP operating income increased by 33% from $111 million to $148 million. Non-GAAP operating margin increased by 8 percentage points from 25% in the year-ago quarter to 33% this quarter. This significant expansion in operating margins was driven by both revenue growth and lower expenses from both of our business units. We expect continued year-over-year improvement in our non-GAAP operating margin throughout fiscal 2010. Please refer to slide 5 for our non-GAAP income statement.

In the quarter, ESM non-GAAP operating income increased to $43 million from $17 million and its non-GAAP operating margin increased by 9 percentage points to 16%. We are especially pleased with our ability to expand our ESM non-GAAP operating margin, and we expect continued year-over-year improvements in ESM’s profitability throughout fiscal 2010.

Our MSM business remains highly profitable and stable. MSM’s non-GAAP operating income increased by 12% to $105 million and its non-GAAP operating margin increased by 3 percentage points to 56%.

Non-GAAP net earnings for the first quarter were $111 million, an increase of 34% from $82 million in fiscal 2009. Non-GAAP diluted EPS for the period was $0.59, up 37% from $0.43 in the prior period. This reflects a non-GAAP effective tax rate for the quarter of 25%. Our effective tax rate was positively impacted by $5 million of non-recurring discrete benefits. We are now assuming a non-GAAP effective tax rate of 29% for the full-year.

These non-GAAP results reflect diluted shares outstanding in the first quarter of 188 million, versus 193 million in the year-ago period.

GAAP operating income in the first quarter of fiscal 2010 was $108 million, compared with $13 million in the year-ago quarter. GAAP net income and fully diluted EPS were $82 million and $0.44, respectively, compared to $1 million and $0.01, respectively, in the first quarter of fiscal 2009. As a reminder, first quarter fiscal 2009 GAAP net income was impacted by a $50 million in-process research and development write-down recorded in connection with our acquisition of BladeLogic.

Turning now to bookings, as Bob discussed we experienced a shortfall in our first quarter bookings primarily related to the economy, the longer ESM sales cycle and the timing of MSM renewals.

Our MSM business, which is lumpy by nature, was impacted by the timing of a small number of large transactions. Fortunately, we have good visibility to contract renewals in our MSM business and the outlook for the full-year remains positive as we enter a period of strong renewal activity.

Economic conditions played a factor in both our MSM and ESM units as new approval requirements drove an elongated sales cycle that caused some delays – but not cancellations – of orders. In fact, for ESM we already closed the largest of these delayed transactions and are working with customers to close the remainder.

In the first quarter, total bookings of $390 million were down 19% from the year-ago period. On a constant currency basis, first quarter bookings decreased 15%.

Total bookings on a trailing 12 month basis were $1.79 billion, down 2% compared with the year-ago period. On a constant currency basis, total bookings on a trailing 12 month basis increased 5%.

The weighted average contract length for total bookings on a trailing 12 month basis was 2.05 years, down 2% from the year-ago period.

After normalizing for contract length, trailing twelve month annualized bookings for the first quarter were $873 million, flat from the year-ago period. On a constant currency basis, trailing twelve month annualized bookings increased 7%. Please see slide 7 in our presentation.

Now let me turn to the performance of each of our business units. For our ESM business unit, license bookings are the best measure of performance. ESM license bookings were $73 million in the first quarter, down 25% from $96 million in the year-ago period. On a constant currency basis, ESM license bookings were down 19%.

The weakness in ESM license bookings was primarily driven by the economy and delays in larger, more complex transactions and was broad-based – impacting all major geographies and product lines.

Despite the shortfall, there were several positive trends in our ESM business, including the continued success in platform sales, as 7 of the 10 largest transactions had multiple product disciplines, the average selling price increased in the mid single digits, and there were more license transactions over $1 million than in the prior period. Although the second quarter is a tough comparison given the strong performance of a year ago, we are confident that our best-in-class sales force, enabled by industry leading technology, will deliver solid full fiscal year results.

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 first quarter, total MSM bookings on a trailing twelve month basis decreased 8% to $690 million with an average contract length of 2.87 years. On a constant currency basis, total MSM bookings for the trailing twelve months were down 2%.

After normalizing for contract length, total annualized MSM bookings for the trailing twelve months were $241 million, down 9% from $264 million compared to the year-ago period. On a constant currency basis, total annualized MSM bookings for the trailing twelve months were down 2%. The mainframe business is traditionally a lumpy business and as a result, we can see bookings vary from quarter to quarter. Based on the timing of MSM renewals we expect solid full fiscal year results, with particular strength in the second half of the year.

Turning to revenue, total revenue for the quarter was $450 million, up 3% from $438 million in the first quarter of fiscal 2009. On a constant currency basis, revenue grew 6%. License revenue in the first quarter was $167 million, an increase of 12% from $149 million a year ago. On a constant currency basis, license revenue increased by 15% in the quarter. ESM license revenue was $97 million, up 8% from $90 million in the year-ago period. MSM license revenue increased by 18% to $70 million.

During the quarter, the percentage of license bookings that was deferred was 26%, significantly lower than 49% in the year-ago period. The lower ratable rate was driven by the lack of large, complex transactions that tend to be more ratable. As the number of large, complex transactions is expected to increase over the rest of the year, we expect the ratable rate to increase to the mid-50s for the remainder of this fiscal year.

For the first quarter, maintenance revenue of $251 million was down 1% from $254 million compared to a year ago. On a constant currency basis, maintenance revenue grew 1%. ESM maintenance revenue of $136 million was down 1% from $137 million and MSM maintenance revenue of $116 million was down 2% from $118 million compared to the first quarter of fiscal 2009. On a constant currency basis, ESM and MSM maintenance revenue were up 2% and flat, respectively. In addition to the negative impacts of currency, maintenance revenue was also impacted by the timing of renewals. We expect maintenance revenue to grow sequentially in the second quarter.

Professional services revenue, which is included in the ESM segment, decreased by 6% from $34 million to $32 million. On a constant currency basis, professional services revenue increased 1%.

From a geographic perspective, we had total revenue growth in the first quarter across all regions except for EMEA.

Moving next to operating expenses, we remain extremely focused on controlling expenses. The proactive reductions we made in the second half of the last fiscal year positions us well throughout fiscal 2010. During the first quarter, non-GAAP operating expenses were $302 million, down 7% from $327 million in the year-ago period. On a constant currency basis, non-GAAP operating expenses were down 2%.

Looking at our business units, ESM non-GAAP operating expenses were $221 million, a decrease of 9% compared to the year-ago quarter. MSM non-GAAP operating expenses were $81 million, 3% lower than the year-ago quarter.

We remain committed to implementing additional measures to improve efficiencies and reduce non value added costs throughout the organization. A recent example is the creation of a financial shared services organization that will drive improved transaction processing and efficiency gains. We also are focused on opportunities to lower our cost structure by reducing temporary labor and third party professional services, reducing our real estate footprint, centralizing procurement activities and reducing hardware costs and other capital expenditures.

Now turning to the balance sheet, our financial position remains strong as evidenced by our strong balance sheet and cash flow from operations. Our strong financial position was also validated recently when both Moody’s and S&P revised their outlook on BMC to positive from stable.

Total deferred license revenue at the end of the first quarter was $550 million, down 10% sequentially. This sequential decline is a direct result of the previously mentioned low ratable rate and lower than expected first quarter license bookings.

During the quarter, we deferred $28 million of license revenue, or 26% of license bookings, and recognized $90 million of deferred license revenue from the balance sheet.

Total deferred revenue decreased 3% sequentially to $1.73 billion, driven by the decline in deferred license revenue. Software development costs on the balance sheet were $121 million, down 1% compared to the fourth quarter of 2009, as we capitalized $14 million and amortized $16 million during the quarter. Cash and investments at June 30 grew sequentially by 10% or $116 million and now total $1.3 billion. Our net cash position was $973 million.

For the quarter, cash flow from operations was $155 million, up 3% from $151 million in the year-ago period. On a constant currency basis cash flow from operations grew 23% year-over-year. First quarter cash flow from operations also reflects a year-over-year increase of $21 million in cash income taxes paid.

These first quarter results reflect strong cash collections, normal seasonality, and reduced bookings. We had a significant reduction in DSO’s to 40 days from 60 days in the fourth quarter. We expect that DSO’s will trend upward for the rest of the year and by year end be at a level similar to the prior year. Although the weakness in first quarter bookings will have a direct impact on second quarter cash flow, we remain on track to achieve our annual cash flow goal.

During the quarter, we remained committed to share repurchases. We repurchased 1.4 million shares for a total of $50 million. We plan to increase our share repurchase program in the second quarter. This change in repurchase activity reflects our strong financial position, our expectations regarding fiscal 2010 operating cash flow and our view as to the value of our shares relative to other opportunities.

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

Robert E. Beauchamp

Thank you, Steve. As we move through fiscal 2010, our core markets, our business strategy and positioning, as well as our ability to build value for shareholders remains strong.

We operate in a difficult environment and expect that the economic conditions will remain challenging throughout the fiscal year. We felt the impact of the weak economy in first quarter bookings and believe that it will also affect bookings during the remainder of the year. We took these factors into consideration in determining our performance estimates for the remainder of the year.

Based on our current expectations, we remain committed to achieving our annual bookings goal and are looking to a strong second half. As I mentioned, we are increasing our full-year non-GAAP EPS guidance and reiterating guidance for all other key metrics. As Steve noted, we plan to increase our share repurchase activity in the second quarter.

For fiscal 2010, we expect non-GAAP earnings per share in the range of $2.47 to $2.57 per share, which at the midpoint would represent a 12% increase. Our non-GAAP EPS estimate assumes an effective tax rate of 29% and excludes an estimated range of $0.58 to $0.62 for special items, including expenses related to the amortization of acquired technology and intangibles, stock-based compensation and restructuring activity.

The assumptions underlying this full year fiscal 2010 estimate include: total bookings and revenue growth in the low single digits on a reported basis. We expect the constant currency growth rates to be 100 basis points higher for revenue and for currency to have no impact on our full-year bookings; a license bookings ratable rate in the low 50’s versus 50% in fiscal 2009 as we expect to return to a more normal volume of large transactions with complex terms and conditions; and a continued improvement in non-GAAP operating margin.

We expect full year fiscal 2010 cash flow from operations to be between $600 million to $650 million. We are now assuming that increased profitability and the geographic distribution of earnings will drive cash income taxes $60 million higher for the year, or $20 million higher than previous expectations. Given current exchange rates, we are assuming that currency will negatively impact full-year cash flow by $40 million, or $20 million less of an impact than our previous expectations. As in fiscal 2009, we expect virtually all of the cash flow from operations to be derived from cash earnings versus changes in working capital.

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

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go first to Brian Denyeau with Oppenheimer & Company.

Brian Denyeau - Oppenheimer & Company

So if we can just talk about bookings for a second, and I think you might have touched on some of this but in terms of your -- what you are basing it on and your guidance for the year, are you assuming the sales cycles for ESM look the same as they do this year? If I look at your numbers, you are basically talking about high-single-digit bookings growth for the rest of the year.

Stephen B. Solcher

Actually what you are looking at for total bookings, you are looking at low single digits in total for the year and that would be both -- I would say both license and maintenance in that case, and probably pretty similar in both BUs, so both ESM and MSM.

Brian Denyeau - Oppenheimer & Company

Right, but given the hole that you are in, right, you are going to have to grow high single digits for the [rest of the year] --

Stephen B. Solcher

Oh, yes, now I get your question -- yes, that’s correct.

Brian Denyeau - Oppenheimer & Company

But I guess what I am getting at is given what you saw in the first quarter, are you assuming the same environment for the entire year?

Stephen B. Solcher

Well, the thing that we tried to pick up on the call is the one thing that’s a little bit different in the latter half of the year is on the mainframe side of our business, we actually have end of contract dates that are going to force customers to do something. So in this quarter where you didn’t have a lot of those end contract dates, what we do see and have a lot of visibility on is in quarters two through four, we are seeing a complete shift in the number of opportunities that are in front of us.

Brian Denyeau - Oppenheimer & Company

And your assumptions on the ESM side?

Stephen B. Solcher

The ESM side I would say is it progressively gets better, so we are factoring in, in our viewpoint that the economy remains really tough that as you get into the December and March quarters, the economy starts to improve.

Robert E. Beauchamp

We’re assuming that Q2 will have -- will be what we saw in Q1, which will be worse than we saw all of last year and it will be another tougher close cycle, a longer close cycle so we’ve essentially factored that into the expectations for Q2, and then we believe based on our own information but also what we just hear and read externally that the -- in Q3 and Q4, it should get a little bit easier.

Brian Denyeau - Oppenheimer & Company

Okay, great. Thanks, guys.

Operator

Your next question comes from Israel Hernandez with Barclays Capital.

Israel Hernandez - Barclays Capital

That actually was my question but can we talk a little bit about the performance of the data center, the automation business? You know, the old BladeLogic, can you talk about some of the trends that you are seeing there? The pitch here with automation, is that this -- that the technology and platform saves money, is that message still resonating with customers and how is that unfolding here as we move through the recession?

Robert E. Beauchamp

It’s probably the easiest product in the portfolio to sell from the standpoint of the ROI is pretty simple to explain to customers. There’s a movement out there. It’s almost like there’s a -- the conventional wisdom suddenly became that if you don’t have data center automation technologies, you better get some. So there’s more about less demand creation than there is just supplying and working with the customers on quicker ROIs.

That said, because we are doing the all-in sales model, all of our -- and the fact that seven of our 10 largest transactions even in Q1 which was obviously light on large transactions, even though we continue to see more multi-product sales, you see the products move up and down together. So we have a strong quarter, everything will move up. We have a weak quarter, everything will move down, more so in ESM than in the past when we were selling the products as individuals.

But back to your original question, automation is definitely -- we are very excited about that. It’s definitely still a very hot topic. The sales calls I’ve been making, I’m making a lot of customer visits. It’s one of the first things the customers want to talk about and one of the quickest, easiest products for us to write ROIs for.

Israel Hernandez - Barclays Capital

Thank you.

Operator

Derek Bingham with Goldman Sachs.

Derek Bingham - Goldman Sachs

I just wanted to make sure I was clear -- when you are saying you have some of these kind of forced contact renewal dates coming up, is it typically the case that you get some early renewals that you might have expected to get in the June quarter? Is that what you are saying?

Robert E. Beauchamp

Yes, in MSM. Really for every quarter, when we look at our MSM business, we know exactly when the contracts expire and we know that the odds are extremely high that we will close some sort of transaction no later than that anniversary date. Generally we close it a certain percentage earlier than that, you know, a few quarters. Sometimes well earlier, depending on if the customer has some reason that they want to accelerate the transaction.

We try to avoid accelerating the discussion by throwing long-term links or big discounts at customers. We think that that’s not healthy for the business long-term. We actually think our negotiating business becomes better as we get closer to the expiration date. However, what we did see in June was that we saw a little bit of an anomaly in that the -- kind of the expectation of early transactions didn’t happen, which is okay for the year. For the year, that’s fine. It just means we’ll move closer to the expiration dates, the contracts will be -- frankly the leverage is a little bit better for us. We try to work with our customers and not make it a coercive negotiation. But it is -- the leverage does move towards us as the contract gets near the end and almost -- in every case, we sign some sort of agreement with the customer.

So MSM, we didn’t have -- we had very few expirations in Q1 and they mount over the course of the year and increase from this point forward, and on into the next year, actually.

Derek Bingham - Goldman Sachs

Okay. Bob, could you give a little more color on the changes in the sales force that you alluded to? I just want to dig in there a little bit deeper in terms of how that impact manifested itself and kind of how long it’s going to take for those changes to kind of flow through or normalize?

Robert E. Beauchamp

Absolutely. So first, we started about a year ago really upgrading the sales force. We have some great sales people at BMC and we have had them for as long as I’ve been here but we recognize that as we were moving towards BSM and really selling a solution, a platform, we needed to have one of the top quality sales organizations in the world who could sell to CIOs and maybe even to Chief Financial Officers. We traditionally had a sales organization more aligned to selling to technical buyers and to procurement groups. They were very good at it but that’s where they were.

So we began that process. We brought in our new head of ESM sales. We began doing extensive training. When we acquired BladeLogic, obviously John McMahon came in from that organization and we began to retool. But we did last year have to run a hybrid model. We still had specialization, we still had specialists in multiple product areas, we had compensation plans that were still more complex and varied because you had some old Blade comp plans and BMC comp plan, et cetera. And so throughout all of last year, we still were dealing with some of the complexities. We couldn’t go all to one sales model, so to speak, or an architected sales model.

As soon as the clock turned over to April 1st, the calendar, we rolled out the new comp plans. In fact, the fastest we’ve ever done in terms of rolling out the new comp plans, the new sales territories, the new org structures. We went to an all-in sales model and that was done in April. So from that standpoint, I think it positions us well for the rest of the year.

But there was quite a bit of change in getting that done. There was also quite a bit of turnover -- you know, you exit -- [this applies as Oracle and all other], BMC and every other enterprise software company have had to deal with through our history, the first quarter is always the most turmoil in the sales organization. You exit the most people, you bring on line more people and you make the org structure changes.

So we knew going into Q1, Q1 is always a little more dicey in terms of the quarter from the standpoint of sales disruption. You’ve got them at their 100% clubs in Hawaii, you’ve got them at their training events, you’ve got them -- the sales comp plans, those sort of things happen and so that happened and we felt that as long as the patterns of Q4 would have continued, we would have been okay in Q1, but it didn’t. The combination of that kind of disrupting the normal disruptive cycle of sales force a little more than usual here and then a change in buying patterns kind of left us more exposed in the last week of the quarter in terms of our visibility to what was happening.

So we’ve analyzed that. We believe that there’s a very high priority on having the salesforce very stable. We’ve spent quite a bit of time going through that with the sales leadership and that for the rest of the year should continue to improve.

I would point out that this sales group delivered pro forma constant currency in Q1 last year 17% growth in license, 25% in Q2, 9% in Q3, and 15% in Q4, so the Q1 we think is the anomaly. This is not a -- this is the same set of people delivering on, who are very bullish on the product portfolio and the market we serve and we think this is just a matter of the pattern change that we were looking for right in the middle of kind of the usual Q1 changes. That was a little more aggressive this year than previous years.

Derek Bingham - Goldman Sachs

Okay, thanks. I just have one point of clarification on the guidance, Steve -- you had talked about last quarter of having kind of the cash flow progression be similar to the seasonality that we saw last year. Given that some of these cash collections will be pushed out, should we expect your fiscal Q2 to be kind of sub-seasonal relative to last year in cash flow?

Stephen B. Solcher

That’s right. That’s what -- you know, in my prepared remarks what I was alluding to is the weakness that we saw in Q1 will definitely impact Q2, so where typically we would enter into the last quarter of our fiscal year with about 65% of cash flow done, what you are going to probably see this year is closer to 50% to 55% of that number done through the first three quarters.

Derek Bingham - Goldman Sachs

Okay. Thanks very much.

Operator

Kevin Buttigieg with FTN Equity.

Kevin Buttigieg - FTN Equity Capital Markets

Thank you. Just a couple of questions -- first of all, with regard to the mainframe renewals that you did have this quarter, any comment on whether those transactions renewed at historical rates or at expanded rates?

Robert E. Beauchamp

Yeah, it was actually quite good. We actually saw some improvement. In run-rate, we saw a -- the annual run-rate again improve for I think it was the ninth quarter in a row. Discounting remained quite good, actually improved. Term lengths did not elongate, so you weren’t looking for the things you would normally see if you see a company trying to maximize bookings for the short-term at the expense of the long-term, you didn’t see any of that out of BMC this quarter.

Kevin Buttigieg - FTN Equity Capital Markets

Okay, and then I guess you were more surprised really by the ESM side than the MSM, although MSM was less affected --

Robert E. Beauchamp

Yeah, MSM was -- wouldn’t have surprised us because it can be lumpy and that just happens. If you remember last year, Q1 was strong and Q2 was poor last year but the year was excellent, right, so it’s just a lumpy business. This was more an ESM phenomenon as it relates to the macro, the slowing of the sales cycle which makes sense because it’s not generally event driven. It’s good old fashioned demand generation, selling new value propositions, so the -- I was involved in the largest transaction that did not close at the end of the quarter, that did close last week and it was unbelievable the amount of steps that that customer had to go through after the ROI was literally five times greater than they needed it to be, after the CFO and the CEO and the CIO and the COO had all gone through it and approved it, after the contract was finished, after the money had been budgeted, they had to go through to each cost center around each of the countries they do business in and have each of the cost center managers sign up for the cost savings by name, sign up for the training and they had to go through all these machinations that were really extraordinary that the CIO took me through as he was explaining why it took so long, and it had nothing to do with our sales process. It had to do all with the customer’s internal approval processes to get buy-in and to make sure that in this case a replacement of HP’s service desk and standardization across the world on our products would be implemented without resistance and the budgets would be there. It was really quite extraordinary to listen to the customer explain that to me and we saw those sort of -- we saw customers we have done business with for years add additional steps to the close cycle. None of them did we lose and they are either closed already or we are working to close them now but it certainly did slow it down.

Kevin Buttigieg - FTN Equity Capital Markets

Okay, and then Steve, your comments about operating margin improvement the rest of the year, was that year over year, quarter over quarter? And given kind of the changes that you’ve made on the sales force side, how does that impact your expectations for improving efficiencies and improving costs the rest of the year? Does that hamper your ability to do so to a certain degree within that area?

Stephen B. Solcher

Not at all. You know, when I look at it, what I was looking at is both year over year and then sequential improvement. Q1 is always a very difficult quarter for us on the operating margin side and so starting out with margins of 33% and then looking out forward for the rest of the year, I remain pretty convinced that we can improve them not only sequentially but also look to improve them year over year. And I -- you know, again, as I said in the prepared remarks, I still believe there is a lot of low-hanging fruit from real estate to other areas where we can improve and just be better and more efficient.

Kevin Buttigieg - FTN Equity Capital Markets

Thank you.

Operator

Michael Turits with Raymond James.

Michael Turits - Raymond James

Regarding the -- it sounds like you are not really looking for much of a pick-up next quarter, more in the second half based on mainframe renewals and on the macro. Is there anything metrically that gives you any visibility that things are going to pick up on the ESM side?

Robert E. Beauchamp

Well, I would just say in general, after this quarter, we went through the most robust pipeline scrubbing forecasting review, I mean, remember, this was all geographies, all product lines, right, so clearly that’s a sign of a macro sort of a shift.

So we really focused on trying to provide good clear vision to the rest of the year. We tried to assume that it didn’t miraculously get easier and in fact, if anything that stays this difficult, we’re not modeling that it gets harder but Q1 was hard enough in terms of those long close cycles. And then we scrub it through there and the result was a sales forecast, a bottoms up and tops down scrub sales forecast that leads us to believe that we can reiterate guidance and actually for the rest of the year and make those numbers. And so that wasn’t done lightly -- there was quite a bit of pepper grinder work that was done for us to come to that conclusion.

Our reps are more productive already. The deals that we are working are exciting. Some of the wins we are doing are really spectacular wins in terms of customers really standardizing on us across the complete product line and so there was quite a bit of work done to get there and we are assuming that the economy remains fairly difficult and doesn’t get any better, at least through the end of Q2.

Michael Turits - Raymond James

Two more quick questions, and just to be sure, you feel there were no real competitive changes, you didn’t lose competitively more than you expected?

Robert E. Beauchamp

No, there were no competitive changes in terms of losses and wins. We can’t -- because we went through it, we can’t say well you know, look, we’re losing more deals to competition. You know, we did see some change in complexion to the competition but it didn’t have an impact. We see CA being very aggressive on pricing in terms of conditions, doing very long-term deals it looks like and so we see that but that didn’t really have an affect on our business. We didn’t see any material impact to our business as a result of that. It’s just a -- more of a color comment that we are seeing. That’s the only thing we’ve seen from a competitor that’s changed, is they appear to be very aggressive in their term lengths and in their -- contract term lengths and in their pricing.

Michael Turits - Raymond James

And then lastly, if I could squeeze in just a question for Steve on the margins, I think you had said that you might be able to do one to two points of margin growth this year. Do you still feel that way? And also on a dollar basis, do you feel like you can hold the expenses at this kind of $302 million -- can you hold it under that [inaudible], you know, within a few million dollars hold it on that dollar basis going forward?

Stephen B. Solcher

Well, on a dollar basis, especially with where rates are today at EUR1.44, I do think that where we’ve had a benefit of currency to expenses this quarter alone was about 5 points of help that on a constant currency basis, expenses were down about 2%. But going forward, again I think there’s a lot of room. I am very optimistic about our ability to manage the expense line and depending on how, as Bob said, how our view of bookings and revenue turn out, we are going to proactively manage to ensure that we hit the OpEx, the operating margins as well as our cash flow goals.

Michael Turits - Raymond James

Okay, thanks, guys.

Operator

Walter Pritchard with Cowen & Company.

Walter Pritchard - Cowen & Company

I’m wondering just a couple of things -- one, if you could talk a bit about the weakness in Europe and if that was widespread of if that was isolated to certain geographies?

Robert E. Beauchamp

Say that again, the weakness in what?

Walter Pritchard - Cowen & Company

Just in Europe, in the EMEA geography, was that isolated to certain areas of Europe or was that widespread within Europe?

Robert E. Beauchamp

Yeah, the northern region was the most impacted, the U.K., et cetera. But by the way, I’ll tell you that that group has some of the strongest opportunities throughout the rest of the year. There’s some really wonderful transactions -- in fact, the large deal that I mentioned that we closed this quarter was in that region.

Walter Pritchard - Cowen & Company

And then Steve, around the ratable mix, did that have everything to do with mainframe large deals or was that also impacted by the ESM large deals and those getting held up and bringing that down?

Stephen B. Solcher

It’s typically both, so in each instance, the rate that we recorded in the quarter was about half of what we were expecting and it was strictly attributable to these large complex transactions. Sometimes it’s even transactions where you have both product areas or both BUs selling to the same customer. So we did see that and again, it’s primarily related to these large transactions and some of them are time-based transactions, so it’s just not terms and conditions. It is where customers commit to doing it for a specific period and then we record that revenue over that period of commitment.

Derrick Vializ

Operator, is he still talking?

Operator

Mr. Pritchard, did you have anything else? If you do, you can press star, one again.

Derrick Vializ

Okay. Well then Operator, let’s take one more question.

Operator

Okay, that will come from Richard Sherman with MKM Partners.

Richard Sherman - MKM Partners

Good afternoon, Bob. I just had a question on the DSO decline, dropping to 40 here -- was that due to the timing of deals or the linearity of the quarter? What was the impetus for the significant drop in the DSOs?

Stephen B. Solcher

Well, I think it’s two things, Rich -- the first piece is I think last quarter when working capital kind of worked against us, I think everybody here really kind of had a rallying cry around trying to collect cash, you know, these outstanding receivables. So I have to applaud the team for going out and really doing what I would say is a pretty incredible job of collecting what was there.

But at the same time, because of the weakness, what we filled back up on the balance sheet, you know, we were short against expectations so typically seasonality would put that maybe down 10 days, not down 20 days. So I would say 10 of the decline is strictly due to seasonality -- the other 10 is we just did a very good job of collecting.

Richard Sherman - MKM Partners

Okay. All right, thanks, Steve. And then maybe on the ratable clarification, I think I was just looking at the press release -- you say low 50s now. It seemed like you were in mid 50s before. I was a little bit confused and I think you said mid-50s, so you are expecting the ratable rate to be now in the low 50s, is that correct?

Stephen B. Solcher

That’s correct -- for the full year, you know, by the time we end the fiscal year, so the full year is probably going to be in the low 50s and it’s strictly driven because we had such an incredibly low rate in Q1 that even having a very high rate through the rest of the year, which is kind of in the mid to high 50s, just mathematically you are going to end up with low 50s ratable rate.

Richard Sherman - MKM Partners

Right, very good. And then maybe two quick ones -- CapEx, is that still expected to be $80 million? And then in terms of the sales reorganization, my understanding was that was across all geographies. It started in Europe and came here into the U.S. I just wanted to make sure that was correct.

Stephen B. Solcher

Let me take the first piece of that -- so CapEx and software cap is still targeted at 80 -- CapEx at 20 and software cap at 60.

Richard Sherman - MKM Partners

Great.

Robert E. Beauchamp

And to your question about sales, that’s correct. It’s a worldwide sales model. The -- and we began it in Europe. It is now across the world. We have about 100 sales people here in training today here in Houston and primarily inside sales doing training today. We’ve got a consistent model around the world now. There’s no big changes needing to happen to the sales force. We’ve got the comp plans out, the sales models are out, we are focused on sales force and productivity. We should add as many as 50 new productive heads coming online -- productive meaning they have been here a while, so they have had a chance to be trained, be in the territory. So we are seeing a number of sales reps come up that are productive sales force come up and we are going to continue to grow that as well throughout the year. And so the sales force change is really -- that is behind us and at this point, we should see nothing but improvement in productivity and in the output of particularly the ESM sales force for the remainder of the year.

Richard Sherman - MKM Partners

Very good. Thanks for taking my questions.

Robert E. Beauchamp

All right. Operator, we’re -- thank you all for joining us today. We appreciate it. We look forward to taking your calls individually if you have any questions we can answer for you. It’s a fascinating operating environment we are living in. The visibility in the individual month or individual quarter is more difficult than it’s been for some time, if not in my memory but nonetheless over the year, as we can see over longer periods of time fairly clearly, we feel obviously quite good about our business for the entire fiscal year and as such, we feel good about being able to reiterate our guidance or in some cases raise the guidance for the fiscal year and we look forward to working with you throughout the year and discussing our results and opportunities ahead of us. Thank you for joining us.

Operator

That concludes today’s conference. Thank you all for your participation.

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Source: BMC Software F1Q10 (Qtr End 6/30/09) Earnings Call Transcript
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