BMC Software F2Q10 (Qtr End 9/30/09) Earnings Call Transcript

Oct.29.09 | About: BMC Software, (BMC)

BMC Software, Inc. (NASDAQ:BMC)

F2Q10 Earnings Call

October 29, 2009 5:00 pm ET

Executives

Derrick Vializ - Investor Relations

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

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

Analysts

Phil Winslow - Credit Suisse

Kevin Buttigieg - FTN Equity Capital Markets

Yun Kim - Broadpoint Amtech

Richard Sherman - MKM Partners

Abhey Lamba - ISI Group

Michael Turits - Raymond James

Derek Bingham - Goldman Sachs

Tim Klassell - Thomas Weisel Partners

Kirk Materne - Rafferty Capital Markets

Matt Headburg - RBC Capital Markets

Operator

Good day, everyone and welcome to today’s BMC Software second quarter fiscal year 2010 earnings results conference call. Today’s program is being recorded. At this time for opening remarks, I would like to turn things 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 second quarter financial and business performance. After that, Stephen Solcher, our CFO, will provide additional financial and operational detail. 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 strategies, acquisitions and other statements that are not statements of historical fact are considered forward-looking statements.

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

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

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

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

Robert E. Beauchamp

Thank you, Derrick. Good afternoon and thank you for joining us on today’s call. I am pleased to report that BMC Software delivered a solid second fiscal quarter in both business units and across almost all of our key financial metrics. We continue to be on track to achieve or exceed our key business and financial goals in fiscal 2010.

During the second quarter, our ESM and MSM businesses gained strong momentum compared to the first quarter. We continued the trend towards larger platform deals which lengthens the sales approval cycle and we closed on the more complex ESM transactions we mentioned during our last call. At the same time, we began to benefit from a more favorable MSM renewal cycle.

We continue to invest in our business to enhance our market leadership through internal development, market alliances, and acquisitions, while maintaining our strong financial discipline and controlling expenses. The end result was another quarter of solid cash flow and increased earnings.

Let me now share with you some key highlights for the quarter compared to a year ago. Total bookings rose 6% to $431 million and 4% adjusted for currency. Total revenue of $462 million was flat on a constant currency basis despite a seven percentage point increase in our ratable rate.

Non-GAAP operating expenses were down 10%. Non-GAAP operating margin was 38%, up 6 percentage points. Non-GAAP EPS was $0.66, up 18%. Cash flow from operations was $93 million, an increase of 24%, and our balance sheet remained strong with approximately $1.3 billion in cash and investments and $1.7 billion in deferred revenue.

I am very pleased with our performance so far this year and we are determined to continue this progress over the course of fiscal 2010 and beyond. I am proud to say that BMC is widening our lead in business service management. Organizations around the world and in every industry are using BSM to reduce the cost of running IT, increase business impact, improve quality of service, manage risk, and provide transparency to business stakeholders.

Since launching the first comprehensive vision of BSM, BMC has been a driving force in the adoption of today’s IT management standard. Today we are taking the next big step forward in the future of enterprise IT management. Dynamic BSM is the next evolution of BMC's management architecture where the goal is to not only address the core requirements of IT management but also support the on-demand provisioning and management of services that leverage new computing platforms, such as virtualization and cloud computing infrastructures.

Consequently, Dynamic BSM leverages the strengths in BMC's BSM platform while enabling customers to deploy and manage a more agile, responsive and efficient IT computing environment.

As Forrester research recently noted, BMC has successfully positioned itself as the thought leader in IT management software. It was also stated that our alliances with firms such as Cisco, Dell, and VMWare position BMC as the most valuable player in IT management software. These are two strong statements from one of the technology industry’s top consulting firms. Our success in this market, as well our ability to drive shareholder value, ultimately depends on the performance of our two business units, Enterprise Service Management and Mainframe Service Management.

First let’s discuss our ESM business. The advancements we are making to our ESM solutions continued to receive considerable industry attention. For example, we are happy to note that Gartner has positioned us in the leaders quadrant of their recent report, Magic Quandrant for IT Service Desk. To be considered a leader, we needed to demonstrate clear strengths on two dimensions -- completeness of vision and the ability to execute.

One of the keys to our ESM strategy and to our success is our continued ability to anticipate changes in the technology landscape and to capitalize on areas of higher growth potential. This includes extending our BSM offerings to virtualization environments and cloud computing environments.

While customers will aggressively explore these new computing paradigms, it is important to understand that they will retain significant parts of their existing computing environment. As a result, BMC's distinct competitive advantage is to provide customers the ability to seamlessly manage their heterogeneous physical, virtual, and cloud computing environments with one comprehensive management platform.

Large organizations that are considering moving applications and infrastructure to a cloud environment must first implement and address the management challenges of highly virtualized IT infrastructures. In a highly virtualized environment, the management challenge is exacerbated on two fronts -- one, there is a dramatic increase in the rate of change for both applications and the underlying infrastructure, and two, there is far more complexity associated with the configurations of those virtualized infrastructures.

Our BSM platform delivers a proven and service-centric approach to the deployment and ongoing management of virtualization technology. With new capabilities that address virtual life cycle management, essentially the ability to manage the creation, ongoing use, and decommissioning of virtual machines, as well as performance and compliance management of virtual machines, our customers can rapidly take control of their virtual infrastructures.

Furthermore, at VMWorld in September, we announced several cloud initiatives. BMC's BSM for cloud computing and BSM for virtualization help customers harness the power of virtualization and enable private cloud computing environments at their own pace. With new capabilities that address virtual life cycle, performance and compliance management, our customers can rapidly take control of their virtualized infrastructures.

From this foundation, organizations can move to complete private cloud management using the same BSM platform.

The attraction to cloud computing, including both private and public cloud environments is powerful, particularly in today’s cost-sensitive, service-oriented IT organization. BMC is already helping enterprise customers and service providers realize this potential.

For example, we continue to expand our BSM ecosystem through strategic alliances. We have formed powerful alliances with Amazon, Netapps, Macaffee and Cisco in order to build the most comprehensive platform that manages business services across enterprise and cloud computing environments.

Last quarter we discussed our alliance with Amazon web services. Together with Amazon, we are providing mutual customers with a flexible and scalable way to extend enterprise class solutions to the public cloud. Werner Vogels, CTO of Amazon.com, said BMC and Amazon are collaborating to make sure customers can get the benefits of the cloud while using their familiar processes, tools, and mechanisms to manage and monitor their systems. BMC, Blade Logic, and BMC Atrium Orchestrator are best in class products that allow customers to seamlessly extend their data centers with the infinite resources that the cloud offers them. BMC has also demonstrated to be a major innovator in the cloud management space, which makes BMC such an excellent partner for Amazon to work with.

To provide cloud environments with a high level of automation, management and security safeguards, we teamed up with Netapp, the computer storage and data management company. BMC and Netapp customers will benefit from a fully automated end-to-end cloud infrastructure, beginning with the initial service request to provisioning, deployment, management, and decommissioning of resources. Automating these processes will enable customers to save time and money, reduce compliance risk and help IT organizations stay focused on meeting the needs of the business.

Our alliance with Macaffee bridges enterprise IT operations and IT security to provide proactive remediation of security violations to ensure compliance with corporate policies and regulatory requirements, resulting in lower business risk, reduced cost, and high availability. We also continued to work closely with Cisco on delivering a unified platform for provisioning and compliance in their unified computing system.

Our acquisition of Tidewave systems, which we closed last week, is another example of how we are investing to enhance our BSM leadership. Tidewave provides leading application discovery and dependency mapping solutions to manage and maintain complex data center environments across heterogeneous infrastructures.

With Tidewave, BMC helps IT organizations gain deep visibility and a clear understanding of the critical business services and their associated relationships to specific IT resources. This enables more timely and accurate change and configuration decisions and delivers improved services to the business. This is especially important for IT organizations that are transitioning applications and services to cloud computing environments.

So clearly we are investing internally through R&D and externally through partnerships and acquisitions to enhance the value of our BSM platform. This is all part of our strategy to transform our organization to a strategic partner for our customers. As we do so, we believe our technology and our platform will become more valuable. For example, for our ESM license business overall, we achieved an increase in our average selling price. In addition, we continue to increase the number of wins for large platform deals. In the second quarter, we had 20 ESM license transactions over $1 million. Our customers are truly standardizing on our BSM platform as more than half of those transactions and five of our top 10 license transactions included all product disciplines. This implies that customers increasingly view us as a strategic partner rather than a traditional point tool vendor.

During the second quarter, we saw multiple platform wins in the financial services industry and the government sector. Europe had a strong quarter, as half of our 10 largest ESM transactions came from EMEA. Some of our ESM platform wins include HCL Comnet systems and services, Logica, MetLife, and Circo. As an outsourcer, and one of India’s largest electronics, computing, and IT companies, HCL won several major infrastructure management customers and chose BMC to manage these important contracts as we had the credibility and the breadth of solutions for BSM.

Logica, a leading IT and business services company, wanted to consolidate its multiple service desk onto a single ITSM platform to better serve global customers, reduce their costs, and position themselves as a leader in their market. Logica chose BMC as its company-wide platform for IT service management by replacing multiple competitive technologies around the world and standardizing on BMC.

MetLife, the global financial services company, ranked 39th of the Fortune 100 companies, continued to standardize on our entire BSM platform. This customer added BMC's BladeLogic as the solution to bring its production environments into a continuous state of compliance. And to reduce IT costs and improve customer satisfaction, CIRCO, a leading provider of professional technology and management services, selected BMC's cohesive integrated BSM platform. As part of standardizing on our complete platform, CIRCO was able to consolidate service desk operations across its entire company.

With the changes we have been making to our sales force, we believe we are building one of the best software sales organizations in the industry that can compete against anyone. This significant transformation has temporarily reduced the tenure and productive sales capacity of our organization compared to the year-ago period and impacted ESM license bookings in the first half of fiscal 2010. However, we are very encouraged by the progress we have made to date as we believe the quality of our sales organization as measured by the productivity of our tenured quota carrying sales reps has improved and that the long-term prospects of our business is very promising.

We believe our new sales organization will provide BMC a competitive advantage for the long-term.

As you can see, we have made several important investments to our ESM business unit throughout the quarter and at the beginning of this quarter. These investments, as well as our strategic partnerships, are demonstrating good returns in terms of the customers we are winning and we believe that additional progress lies ahead.

Turning now to our MSM unit, one of the ways that we remain a leader in this market is by staying close to our existing customers and new prospects. We are constantly doing research to understand and anticipate market needs and opportunities. Every year, for example, we conduct a worldwide survey of mainframe users. The survey has become a fundamental benchmark as more than 1,500 global mainframe users provide insight on the current and future state of the mainframe market.

According to the survey, mainframe customers have been leveraging the economic slowdown to retool and innovate in advance of the return to growth that will come with economic recovery. Spending on operational improvements now is important to ensuring stable and efficient operations and potentially securing competitive advantage as the economy recovers.

And BMC is positioning its current and new MSM customers from banking to transportation to telecommunications to ride the recovery wave, cutting costs, improving efficiencies, and increasing automation across the mainframe market and beyond. Our customer support satisfaction ratings are very high as we continue to provide world class customer support. And with the recent acquisition of MQ software, it is clear that we continue to invest in this important business. The MQ software acquisition created a one-stop shop for monitoring messaging middleware and business transactions across both mainframe and distributed environments.

Last month, our new briefing on middleware management was standing room only, indicating the significant interest in this offering by our customers. Customers also depend on BMC for the latest in mainframe innovations. During the second quarter, our industry leading research and development team continued to enhance some of the most compelling product lines and value propositions in the mainframe software marketplace, including new solutions for job scheduling, capacity planning and database management.

We continued to increase the MSM install base by adding 18 new customers, the majority of which were from the job scheduling product line. One of our new customers, the University of Texas at Arlington, chose our job scheduling workload automation solution to help them manage their batch environment.

In addition 52 of our existing customers added new products or made competitive replacements in favor of our MSM solutions. Some of our largest existing customers include Banc of America, U.S. Bank Corp. and the Internal Revenue Service. Some of the competitive replacement wins include Excelis, where the BMC main view solution replaced ASG; [Labcorp], where BMC BB2 solutions replaced IBM products; and the United States Postal Service, where BMC's main view’s CMF monitor generated significant hardware savings over the product it replaced.

MSM bookings from new customers and new product sales continued its momentum for the first quarter, growing over 70% compared to the year-ago period. And we once again grew the annual run-rate of our top 15 transactions. This is the 10th consecutive quarter where we have seen an increase in the run-rate of our largest transactions.

Looking forward, we expect to see continued strength in MSM renewals as we move into the second half of the year and the first half of fiscal 2011, as well as continued growth in our new business sales initiative across the entire MSM portfolio.

As we look over the remainder of fiscal 2010, we know that we are well-positioned in the current global economic environment with market leadership across both our ESM and MSM businesses. Although this environment remains challenging, there are hopeful signs on the horizon with industry analysts expecting the economy and IT spending to improve during the second half.

We will remain highly disciplined in how we run our business in order to yield greater sales productivity and business process efficiencies to support long-term growth, and we continue to maximize the performance of our ESM and MSM business units.

I will talk more about our current outlook for fiscal 2010 later in the call but first, here is Steve Solcher, who will provide more insight on our financial results.

Stephen B. Solcher

Thanks, Bob. We are pleased with our business and financial results in the second quarter and as Bob indicated, we made progress in a number of key areas, from expanding our BSM platform to enhancing our technology leadership to strengthening our ability to serve customers.

We are especially proud of our solid top line execution and bookings performance in the quarter, where we were able to close virtually all of the large transactions held over from the first quarter along with our second quarter forecasted transactions.

Our ability to control our expenses also contributed to positive bottom line results. As a result, we further improved several key financial metrics -- bookings, non-GAAP operating margin, non-GAAP earnings, and cash flow from operations. Our balanced performance so far this fiscal year underscores the strength of our business model and mix. As you know, we have two businesses with different dynamics and goals that both play in a central role in our business service management strategy. In addition, the steps we have taken in recent years to improve our efficiency by streamlining our infrastructure and operations continue to pay dividends. We believe there are additional opportunities to realize further efficiencies ahead.

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

In the second quarter, non-GAAP operating income increased by 18% from $149 million to $175 million. Non-GAAP operating margin increased by 6 percentage points from the year-ago quarter to 38%. Please refer to slide 5 in our conference call presentation material for our non-GAAP income statement.

ESM’s non-GAAP operating income increased to $71 million from $40 million and its operating margin increased 12 percentage points to 26%. We are especially pleased with our ongoing efforts of expanding ESM’s non-GAAP operating margin and remain committed to continued year-over-year improvements in ESM’s profitability.

MSM’s non-GAAP operating income was $104 million for the quarter, compared to $109 million in the year-ago period. MSM’s non-GAAP operating margin was 56% compared to 58% a year ago. These results include the impact of the acquisition of MQ software during the quarter.

Non-GAAP net earnings for the second quarter were $123 million, an increase of 15% from $108 million in the second quarter of fiscal 2009. Non-GAAP diluted EPS for the quarter was $0.66, up 18% from $0.56 in the year-ago period. This reflects a non-GAAP effective tax rate for the quarter of 29%.

These non-GAAP results reflect diluted shares outstanding in the second quarter of $187 million versus $192 million in the year-ago period. GAAP net income in the second quarter of fiscal 2010 was $135 million compared to $106 million in the year-ago quarter. GAAP net income and fully diluted EPS in the second quarter of 2010 were $94 million and $0.50 respectively, compared to $70 million and $0.36 in the second quarter of fiscal 2009.

Turning now to bookings -- in the second quarter, total bookings of $431 million were up 6% from the year-ago period. On a constant currency basis, second quarter bookings increased 4%. Total bookings showed significant improvement compared to the first quarter, increasing 10% sequentially. Total bookings on a trailing 12-month basis were $1.81 billion, down 4% compared to the year-ago period. On a constant currency basis, total bookings on a trailing 12-month basis increased 2%.

The weighted average contract length for total bookings on a trailing 12-month basis was 2.09 years, down from 2.13 years in the year-ago period. After normalizing for contract length, trailing 12 month annualized bookings for the second quarter were $870 million, down 2% from the year-ago period. On a constant currency basis, trailing 12-month annualized bookings increased 4%. 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 continued to be the best measure of performance. ESM license bookings were $109 million in the second quarter, down 9% from the year-ago period. As we discussed during our previous call, we knew that the second quarter was going to be a tough compare, given the strong Blade Logic performance and the increased number of opportunities in our service assurance discipline in the year-ago period. Our results, however, showed significant improvement over the first quarter where ESM license bookings grew over 50% sequentially.

During the quarter, we were able to achieve an increase in the average transaction size, complete 20 ESM license transactions over $1 million, with more than half of these transactions including all product lines, and increase sales rep productivity, both sequentially and year over year. It’s important to note these platform wins are larger, more complex transactions that typically take longer to close. From a geographic perspective, I am pleased to highlight the strong ESM performance in Europe, which increased significantly on both a year-over-year and sequential basis. About half of our 10 largest transactions this quarter came from EMEA.

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 12 months. In the second quarter, total MSM bookings on a trailing 12 month basis decreased 4% to $735 million, with an average contract length of 2.96 years. On a constant currency basis, total MSM bookings for the trailing 12 months were up 1%.

After normalizing for contract length, total annualized MSM bookings for the trailing 12 months were $248 million, down 6% from $264 million compared to the year-ago period. On a constant currency basis, annualized MSM bookings for the trailing 12 months were down 1%. Traditionally, our mainframe business is a lumpy business and as a result, we can see bookings vary quarter to quarter. However, based on the timing of MSM renewals, our outlook for the full year remains positive as we enter a period of strong renewal activity in the second half of this fiscal year.

Turning to revenue, total revenue for the quarter was $462 million, down 1% from $467 million in the second quarter of fiscal 2009. License revenue in the second quarter was $174 million, a decrease of 1% from $176 million in the year-ago period.

On a constant currency basis, both total revenue and license revenue were roughly flat.

ESM license revenue was $106 million, up 1% from the year-ago period and up 3% on a constant currency basis. MSM license revenue decreased 4% on both a reported and constant currency basis.

During the quarter, the percentage of license bookings that was deferred was 56%, higher than the 49% in the year-ago period and the 26% in the first quarter of fiscal 2010. Our higher ratable rate was partially driven by the completion of more complex transactions in the second quarter.

We expect the ratable rate to be in the mid-50s for the remainder of this fiscal year.

For the second quarter, maintenance revenue of $257 million was up 1% from $256 million compared to a year ago. On a constant currency basis, maintenance revenue grew 2%. Maintenance revenue showed improvement compared to the first quarter, increasing by $6 million sequentially. Both ESM and MSM maintenance revenue grew 1% compared to the second quarter of fiscal 2009. On a constant currency basis, ESM and MSM maintenance revenue were up 3% and 1% respectively.

Professional services revenue, which is included in the ESM segment, decreased by 15% to $30 million. This decline was driven by lower-than-expected first quarter signings, more deferred professional services arrangements, and less education revenue.

Moving next to operating expenses, I remain pleased with our continued ability to control our expenses. During the second quarter, non-GAAP operating expenses were $287 million, down 10% from $318 million in the year-ago period. Non-GAAP operating expenses were down 8% on a constant currency basis.

Looking at our business units, ESM non-GAAP operating expenses were $204 million, a decrease of 15% compared to the year-ago quarter. MSM non-GAAP operating expenses were $83 million, up 4% from the year-ago quarter. The year-over-year increase of our MSM non-GAAP operating expenses is primarily due to the acquisition of MQ software during the quarter. At today’s exchange rates, we expect currency to have an adverse impact on our non-GAAP operating expenses as we move into the second half of the fiscal year.

Turning now to the balance sheet, total deferred license revenue at the end of the second quarter was $556 million, up $6 million sequentially. During the quarter, we deferred $100 million of license revenue and recognized $96 million of deferred license revenue from the balance sheet. Given normal seasonality, total deferred revenue decreased 2% sequentially to $1.7 billion.

Software development costs on the balance sheet were $136 million, up 12% compared to the first quarter of fiscal 2010, as we capitalized $29 million and amortized $15 million during the quarter. The level of capitalized software cost was higher than typical quarters due to increased development activity in the quarter, related to major new releases in our automation and assurance disciplines that we expect to launch in the second half of this fiscal year. We expect capitalized software costs to be at more typical levels over the remainder of the year.

Cash and investments at September 30th was $1.3 billion, roughly flat with the previous quarter. Our net cash position was $979 million. For the quarter, cash flow from operations was $93 million, up 24% from $75 million in the year-ago period. On a constant currency basis, cash flow from operations was up 45%.

Second quarter cash flow benefited from strong intra-quarter collections. DSOs increased to 52 days, up from 40 days in the first quarter, as a direct result of strong bookings performance in the second quarter. We expect DSOs to trend up slightly for the remainder of the year.

With a strong first half cash flow from operations of $249 million, we now expect to generate approximately 55% of our annual cash flow by the end of the third quarter. During the quarter, we remained committed to share repurchases. We repurchased 2.1 million shares for a total of $75 million. As of September 30th, the remaining amount authorized in our share repurchase program is approximately $220 million.

So let me briefly sum up -- as we move into the second half, we remain focused on accelerating our momentum in each of our business units, despite a challenging macroeconomic environment. As we have indicated before, we expect to benefit form a more favorable MSM renewal cycle. Our continued expanding leadership position in our core ESM markets and our ongoing focus on operational and financial discipline.

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

Robert E. Beauchamp

Thank you, Steve. As we move into the second half of fiscal 2010, we look forward to seeing improvements in the economy and IT spending. Many of our peers and industry analysts expect these conditions to firm up during the second half. At the same time, we expect to benefit from a favorable MSM renewal cycle. These factors should have a positive impact on the rest of fiscal 2010.

However, while we remain optimistic, we are naturally cautious, given the continuing macro uncertainties and we will continue to monitor economic and business conditions closely so that we can respond appropriately.

As we did last quarter, we are once again increasing our full year non-GAAP EPS guidance and reiterating our guidance for all other key metrics. For fiscal 2010, we expect non-GAAP earnings per share in the range of $2.55 to $2.65 per share, which at the midpoint would represent a 15% increase over last year and a 7% increase compared to our initial fiscal 2010 guidance. Our non-GAAP EPS estimates excludes an estimated range of $0.61 to $0.65 per share for special items, including expenses related to the amortization of acquired technology and intangibles, stock-based compensation, and restructuring activities.

The assumptions underlying this full year fiscal 2010 estimate include total bookings and revenue growth in the low single digits on a reported basis. At today’s rates, we expect currency impacts to have a slightly positive impact on both revenue and bookings. A license bookings ratable rate in the low 50s versus 50% in fiscal 2009, and a non-GAAP tax rate of 29%.

We expect full year fiscal 2010 cash flow from operations to be between $600 million and $650 million, unchanged for prior expectations. This reflects cash income taxes of $60 million higher than last year and a $40 million negative currency impact compared to a year ago.

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

Question-and-Answer Session

Operator

(Operator Instructions) We will go first to Phil Winslow with Credit Suisse.

Phil Winslow - Credit Suisse

Good quarter. Bob, I was just wondering if you could comment a little bit more on the mainframe side, just what you are seeing in terms of pricing. Clearly in previous quarters you’ve talked about a pretty stable pricing environment. Are you still seeing that? And then as you kind of get closer to your bigger renewal base, just what are your expectations for the trend there? Thanks.

Robert E. Beauchamp

I don’t know that there is any material change in the business dynamic on our mainframe business. We see the competitors that are most likely to drop prices and kind of go for the order with whatever it takes pricing are still doing it. I am not sure they are doing anything more or less than they were, and so I don’t know that I have any real change from the previous time. We are doing a very good job. You can see in our MSM transactions the fact that we were able to really grow the run-rate I believe in all but one of our largest 15 mainframe trend deals, our MSM deals. We actually grew the annualized run-rate -- tells you that we are not only signing customers up again, we are signing them up for more money per year and that’s been a trend that has been continuing for some time. That would be difficult to do if we were seeing any material price erosion.

Phil Winslow - Credit Suisse

Great, thanks.

Operator

We’ll hear next from Kevin Buttigieg with FTN Equity Capital.

Kevin Buttigieg - FTN Equity Capital Markets

Thank you. Obviously you showed a nice improvement sequentially in the quarter. What would you characterize the improvement in terms of the economy or in terms of sales force productivity, if you could sort of break it down both ways? You talked about somewhat of an improvement in sales force productivity but how about on the economy side? And what are you looking at from both of those areas in terms of your guidance for the rest of the year?

Stephen B. Solcher

Okay, so in terms of the guidance, we are assuming what we saw in Q2, which was actually not that much different than Q1 in some respects. We adjusted our filters in terms of our forecasting after the Q1 results to assume that it would be more difficult to close large transactions, that we would have deals that looked good at the end of the quarter that would slip and we just assumed that that would continue but through better sales execution, particularly in Europe, we saw really across Europe, across the major countries in Europe, we saw some very nice BSM multi-product sales occur. People standardizing, you heard several of them in the prepared remarks.

So I wouldn’t say the economy got noticeably better between Q1 and Q2. I would say we adjusted our processes to assume what we saw, which was a change in Q1. And we are assuming that same general close rate cycle as we look at the second half.

Kevin Buttigieg - FTN Equity Capital Markets

Okay, and then just a quick question, Steve, on the margin side -- obviously you are doing a great job there. In the second half with the increase in capitalized software being amortized now and then foreign currency, what should we think about in terms of the margin outlook year over year in the second half?

Stephen B. Solcher

I think in the second half, what you should implicit in where we guided for the full year, what you should assume is both on an absolute dollar basis and then as a percentage basis that we would have sequential improvement as well as year-over-year improvement. Now, what I would caution you a little bit is it is not going to be at the same rate and pace that we had in the first half and also I would like to highlight that we are in the second half going to have a much higher deferral rate than we did in the first half, about close to 6 percentage points higher in the second half than we had in the first half, which will be part of that dampening of the margin.

Kevin Buttigieg - FTN Equity Capital Markets

Great. Thanks very much.

Operator

We’ll hear next from Yun Kim from Broadpoint Amtech.

Yun Kim - Broadpoint Amtech

I know you touched on this a little bit on your opening remarks but can you just give us additional overview of where you are in terms of sales force build out for the ESM business? Are you guys feeling comfortable with the current sales headcount and the makeup of the team today or is there still more finetuning left?

Robert E. Beauchamp

I think that Q2 was an important quarter for us in terms of our ESM sales force build out. We really saw the -- if you think about sales force productivity, it’s a function of attrition, total headcount, and productive headcount, and as we have been making changes to our sales force, we’ve been promoting people into new jobs which takes them some time to get productive. We’ve been bringing in new people. We’ve been exiting low performers, et cetera. And in that process, there was some disruption, which I mentioned also in the prepared remarks. I think Q2 we saw was the turning point of that. We see a very nice pipeline of total headcount, new hires coming on board. More importantly, we see the number of productive sales people, so our people who have been here a while now, they have been in training, they have been in their territories and we are about to move them from being classified as non-productive to being productive. That number is a fairly easy number to forecast and we see that moving up fairly significantly here in the quarters ahead. And then the attrition levels, which were quite high late last year, Q1, as we sit here today and as we exited Q2, those are very close in line with our long-term attrition goals. So it’s not quite where we need it to be yet but based on the most current month, it should be almost immediately.

Yun Kim - Broadpoint Amtech

Okay, great. So you are expecting the productivity of the sales force to continue to show improvement, right?

Robert E. Beauchamp

We continue -- yes, but not at the same rate and pace that we had in the first half. So we are expecting continued improvement but not at the same levels that we have seen in the first two quarters.

Yun Kim - Broadpoint Amtech

Okay, and then Steve, the R&D costs showed a sizable sequential decline in the quarter. How much of that was driven by the higher capitalized software costs in the quarter? And was there any other one-time cost savings that happened in the quarter? And then also, is it safe to assume that R&D costs for the next two quarters should go back up to previous run-rate?

Stephen B. Solcher

The answer to that is yes to your last question, and then I think if you just add all of capitalized software back to the R&D line, you will find that the number is pretty consistent from Q1 to Q2. We got a slight benefit in all of our expenses through the FX, which is going to turn in the second half of the year. So currency helped us in the first half. It will be a headwind in the second half.

Yun Kim - Broadpoint Amtech

Okay, great and then if I could just ask one more question -- Bob, can you just talk about the visibility around the MSM renewals in the second half of the year? I think last quarter earnings call you talked about the visibility being good. Can you just explain to us whether or not visibility had changed or improved or remained the same or --

Robert E. Beauchamp

I would say in general, I mean don’t forget, it’s always a lumpy business, so within individual quarters it is a little hard to be too precise but there is no question that we have moved into a stronger season for renewals for the next say four quarters or so. And that’s without any new hardware cycle that might begin between now and then. But we’ve moved into the strong part of the renewal cycle and we feel pretty good about our mainframe business right now.

Yun Kim - Broadpoint Amtech

Great. Thank you so much.

Operator

We’ll hear next from Richard Sherman with MKM Partners.

Richard Sherman - MKM Partners

My question is about the acquisitions, particularly Tidewave, and how those expenses including MQ Series, would flow into the expense line here in the next couple of quarters?

Stephen B. Solcher

Tidewave, we closed that actually in the quarter that we are in, so you didn’t see any expense in that acquisition. That amount, probably in the next two quarters, is going to be less than a couple of million I would say in each quarter. And the same thing with MQ software. We closed it I believe in the August timeframe, so we had very little expense in the current quarter. You should expect about the same amount of expense flowing through into Qs 3 and 4. So not a big number.

Richard Sherman - MKM Partners

Okay, very good. And then maybe on the professional services line, I know you guys have been looking at trying to make that area more profitable -- any thoughts about the progress on that side as you are trying to get that into the positive territory?

Robert E. Beauchamp

A couple of things happened there -- we mentioned more deferred transactions hit us and I would say that the -- in one area that the economy does affect, and I think it’s pretty consistent as you look across everyone in that business, is the education revenue has been under some stress as customers keep their people at home for education. It’s one of the budgets like travel and entertainment and advertising that gets hit in a tough economy. But that said, we are not totally satisfied with our operating performance in services and it is getting as much attention as any item on our portfolio right now. We are going to be looking at that an we’ve got some very good people on that doing a very good job but I think we are going to need to improve the operating performance of that group.

Richard Sherman - MKM Partners

Those are my questions. Thanks very much.

Operator

We’ll hear next from Abhey Lamba with ISI Group.

Abhey Lamba - ISI Group

Thank you. Steve, can you talk about how high can you margins go in the longer term? One of the bear arguments could be margins are kind of beat right now. Where do you see more efficiencies? Do you need revenue growth to get to, get more margin expansion from here?

Stephen B. Solcher

I think we still have plenty of room on the margin side and I say that only when I look at each of our businesses, when you think the full year number for the MSM business is somewhere in the high 50s today and where ESM is tracking, which would be the low 20s, I think there is room on both of them to go higher. I do think we need revenue growth but I also think the expenses that we have today, there’s plenty of room for efficiencies. As Bob was talking about just a minute ago, on the PS side we lost money in the first half. I think we could significantly improve margins. I think the cost of maintenance line, primarily around support, there’s efficiencies as we go into a self-service knowledge base model. G&A itself, I believe there is plenty of savings there around real estate and other overhead type expenses, so there’s plenty. We’re not at a point yet where I believe we can be constrained at the margin level.

Robert E. Beauchamp

Let me add though that right now, you could just take the last question or the first question, Tidewave and MQ -- those two deals have already generated a lot of interest. We had -- the sales force is energized by it. If you look at the portfolio we built out, the sales force changes we are making, we intend to really focus on growth, top line growth of the company. There’s a lot of energy around the company that we have -- the company is in a very good healthy position. Financially it’s got outstanding products and there is really not excuse for us not to improve the top line growth of this company, particularly given the caliber of the sales people and the sales processes that we brought online with those products. So I expect the biggest improvement to be in the area of just top line growth.

Abhey Lamba - ISI Group

Thanks, Bob and lastly, are you seeing any early mainframe renewals or are people still waiting for the end dates on the contract? And what is driving the capacity uplift that you hinted at a little while ago? Thanks.

Robert E. Beauchamp

Well, what’s causing the capacity -- it’s not really capacity uplift; it’s the renewal cycles came in. In fact, one of the things that -- in a strange way it’s actually a positive for us is that the renewals that we have been having this year, typically in years past, the customer would have renewed for more capacity, been more bullish on their growth rates and in this case, they are being a little more parsimonious. They are basically investing fairly close to the lowest level they think they can get away with in terms of their capacity, which means I think that stands well for the next round of contract renewals where customers are much more likely to have underestimated, more likely to be in for early renewals as they exceed their thresholds, et cetera. So it’s just the renewal cycle but it is different this time and it’s a little more conservative on the customers’ part, which we think will extend this renewal period and will bring the next renewal period online earlier. And I apologize, the first part of your question?

Abhey Lamba - ISI Group

Are people waiting for the end of the contract or are they renewing early?

Robert E. Beauchamp

We haven’t seen any real shift in buying behavior in the MSM unit. So as a percentage, early renewals have been tracking what I would say are historical trends.

Abhey Lamba - ISI Group

Thank you.

Robert E. Beauchamp

Well, historical since the economy turned down.

Operator

We’ll hear next from Michael Turits with Raymond James.

Michael Turits - Raymond James

In first quarter, your bookings were light but they seem better this quarter. Would you say that now as the first half overall improved for each of the businesses, that you are back up to your original target level of bookings for the first half?

Stephen B. Solcher

No, if you’ll recall, last quarter we told you that we expected that we would get back on track with MSM but that we would probably not be able to make up all of the Q1 shortfall and that is still where we are. But we are still able to reiterate our guidance on all the metrics for all the factors we already covered in the call.

Michael Turits - Raymond James

And then in terms of the mainframe renewals, are you at the place where you were targeting to be in terms of renewals and the renewal cycle at this point? Have you done as many renewals and to the amount that you expected?

Stephen B. Solcher

I think we are about where we expected to be. The visibility so far to that group has just been improving and improving through the years and right now, we’ve got a pretty good view of it. It’s about where we expected it.

Michael Turits - Raymond James

Two more questions, if I have time -- first, I missed it, on the software capitalization, did you guys say that was really kind of a one-time thing? What was the extra dollar amount over typical and how much margin and EPS upside did it mean in the quarter?

Stephen B. Solcher

It was about roughly on typical trends, it was probably about 12 higher than we would see, and that is really driven from the ESM side, which was associated with product development that we had in really two specific areas, one around the automation space and the other one around our insurance space. It was about -- if you take the full 12, it was about $0.03 to EPS and had about 2 percentage points impact on the margin.

Michael Turits - Raymond James

And then the last question I had is just on the guidance for the full year of revenues and bookings growth in the low-single-digits, you previously had said that there would be no FX impact on bookings and that there would be I think a 1 point headwind to revenues. So I know the FX situation has simply changed and low-single-digits as kind of a wide number but should I view that as on a constant currency basis, the slight reduction and your thoughts about where revenue growth could be?

Stephen B. Solcher

No, you know, I would just -- again, just know that the range is wide. It’s a good three or four points, so we didn’t want to go to mid in either case, so just -- I would assume that on a constant currency basis, that we haven’t really changed our view.

Michael Turits - Raymond James

Okay, that’s helpful. Thanks a lot, Steve. Thanks a lot, Bob.

Operator

We’ll hear next from Derek Bingham with Goldman Sachs.

Derek Bingham - Goldman Sachs

On the productive sales capacity, when do you get -- in terms of productive heads, when do you get back to the kind of year-over-year levels?

Robert E. Beauchamp

I’m not actually thinking about it that way right now. The way I’m thinking about it is we are going to keep growing this thing and I think we are a long way from being able to having the optimal sales capacity and I don’t mean that from the standpoint of where we used to be. I’m looking at it in terms of how competitive our products are, the number of deals we win, the type of deals we are winning. We are just in not enough deals and so I expect that we are going to continue to grow the productive headcount right now and in the foreseeable future. So I don’t -- I wouldn’t guess as to when we will slow down.

I think that we can get to the numbers with where we are right now.

Derek Bingham - Goldman Sachs

I just thought that the comment was that you were essentially undermanned versus where you were last year because of the changes and taking time to get folks ramped up. Is that still the case?

Robert E. Beauchamp

Yeah, that’s true. I was just -- I may have misinterpreted your question. I was just saying that I don’t have a number to get back to as much as I do that a goal to significantly increase the number of productive sales people as long as we believe the market and the products can stand for that level of sales coverage, and I think we are along way from being that number. I think we are a company primarily sales coverage constrained more than any other factor right now, and I can say that with confidence because now that we’ve got such high quality and you are seeing the results of these transactions where you see BSM sold across the board, you are seeing the competitive replacements -- it just tells me that this is the time, this is why I was discussing growth earlier. This is really the time that BMC needs to be increasing its sales coverage and I don’t have any plans for when that stops.

Derek Bingham - Goldman Sachs

Got it.

Stephen B. Solcher

We’ll be in line though -- I mean, the numbers we gave you, the number of productive sales reps we need, the productivity numbers we’ve been tracking can get us to where we need to be for the year.

Derek Bingham - Goldman Sachs

Okay, understood. On the upcoming quarters that are more of the same in terms of big renewal quarters, I think these are the two big ones, if I understand that correctly, for mainframe renewals -- I mean, just to put a little finer point on it which of those is the bigger quarter in terms of the visibility that you have, just in terms of how we model the bookings?

Stephen B. Solcher

You know, I think actually they are pretty equal. December I would assume would be probably the better of the two, only because December is a big calendar year-end event and I think you will see that probably being one of the stronger quarters but as you’ve said, Derek, they are both equally pretty large opportunities.

Derek Bingham - Goldman Sachs

Okay, and --

Robert E. Beauchamp

Just the other thing, Derek, is recognize -- I mean, as you know, that if two -- if our two or three largest deals went from one quarter to the other, it changes the outcome of that question.

Derek Bingham - Goldman Sachs

Is this continuing to -- you know, does the wave continue to bleed over into June for these renewals?

Robert E. Beauchamp

Well, it’s primarily -- I mean, it’s not -- there’s not an abrupt clip but it is primarily a four quarters phenomenon. But again that assumes that we don’t see any other hardware cycles and we don’t see the economy pick up materially and there is a lot of other things that historically we believe would occur.

Derek Bingham - Goldman Sachs

Okay, fantastic. If I could, on Cisco, I know your last quarter was the first time it had just started shipping. Anymore color you could give in terms of the volumes or the attach rate that you are seeing for Blade on those boxes?

Robert E. Beauchamp

I can give you some comments on it. The -- I was in a customer call today with a Fortune 100 CIO who is here in our briefing center and as I mentioned -- by the way, our briefing center will have an absolute record number of companies in it next week and coming off a very strong week this week with CIOs now a regular part of the briefing center. And what this particular CIO said to me is that they took one of the early boxes in June. It is still in a pilot mode as are most of the companies that have taken in one box or two boxes just to kick the tires, but his comment to me today was that he has been a CIO a long time and he doesn’t get that excited about new technologies often but he is excited about this and we are working with them. In fact, he had just had meetings with the top people at Cisco in the last two days and he was here at BMC and he was here to talk about the automation technology that we have as part of that relationship. So we are seeing a lot of just kind of grass roots interest in this, a lot of customers, a lot of interest, a lot of discussion. We see strong pipeline building for blade logic in general but at the end of the day, we just have to wait and see how many boxes Cisco ships and it’s a little too early to tell because it is still primarily a lot of pilots.

Derek Bingham - Goldman Sachs

Makes sense -- thanks very much.

Operator

We’ll hear next from Tim Klassell with Thomas Weisel Partners.

Tim Klassell - Thomas Weisel Partners

First question has to do with EMEA -- you guys are sort of bucking the trend a little bit there. Can you sort of -- are there any particular regions over there that show a particular strength or was it across the board?

Robert E. Beauchamp

It was really pretty much across the board. We did -- we had some wonderful wins in France. We had really some of the best wins in the company was in the U.K. The -- I am trying to think if there were any anomalies that I could point to but I can't think of any off the top of my head. Steve, do you have any comments on that?

Stephen B. Solcher

No, I just think -- I think Europe was closer to making a lot of changes in the field sales force and I think what you are seeing happening in Europe is that the leadership in EMEA is starting to execute as we expected. So I think you are going to continue to see hopefully strong results out of Europe in the foreseeable future.

Robert E. Beauchamp

Yeah, when we began to make our changes to the sales force, we started first and fastest in Europe, and that team is I believe now the results of that is really starting to come home.

Tim Klassell - Thomas Weisel Partners

And that was my follow-on -- if that’s the case, then maybe the U.S. sort of lagging by six months or so? Would that be --

Robert E. Beauchamp

Yeah, maybe -- I’m not sure six months is -- but that’s probably not a bad guess in terms of just their evolution and the transformation they’ve gone through.

Tim Klassell - Thomas Weisel Partners

And then jumping over to the large deals that you got visibility into, how are your customers feeling about term length? Is cash still king? Are they going to want to shorten up some of the term lengths or what have you? How do they feel about that at this point?

Robert E. Beauchamp

You know, what we have seen is in the larger transactions, we are actually seeing the reverse. We are seeing customers actually committing to longer than a three-year life, so I see that as a little bit of bullish. We center most of our, especially around the mainframe side, around a three-year term but we have seen the slight increase in term length and I think for the full year, I think at a corporate level it might be two months added to our -- what we call our WATL, which is the weighted average term length, but we are seeing with the larger deals that they typically will drive a higher term length, not a shorter term length.

Tim Klassell - Thomas Weisel Partners

Great, and one final quick one here -- if we are in the inflection point into a recovery, what products would be the most economically sensitive, the assurance products? I’m guessing but what do you think in your product portfolio is the most economically --

Robert E. Beauchamp

You mean which ones are likely to pick up the strongest?

Tim Klassell - Thomas Weisel Partners

Yes.

Robert E. Beauchamp

I am not sure that I have a thoughtful answer. I think your initial thought may be right -- assurance is probably the one that they could sit on the longest and let that age because most customers already had assurance technologies that even if they are generations old, they would still kind of be holding up the enterprise. And I think it is more likely that they would be prepared then to do upgrades and generationally upgrade their assurance environment. I think that makes sense to me. I don’t know that I could prove it mathematically but it makes sense to me.

Tim Klassell - Thomas Weisel Partners

Thank you very much.

Operator

We’ll hear next from Kirk Materne from Rafferty Capital Markets.

Kirk Materne - Rafferty Capital Markets

I guess my question would be for Steve -- could you just talk a little bit about where the margins are currently on ESM and if you adjusted for some of the software capitalization? Further upside on margins from here, is that going to be more dependent upon just better license bookings or are there still some opportunities in terms of cost efficiencies? Thanks.

Stephen B. Solcher

I think it’s very similar to the question that I was asked a little bit earlier in the sense that I think we do need growth but I think there is plenty of room still on the expense line just look at the COGS number for ESM, which includes professional services alone, the first half we lost money. We don’t expect to lose money in this business so that’s a big turn.

I think there is plenty of room on the G&A side. If you took out what I’d say the kind of the unique nature of software cap this quarter, you are looking in the quarter somewhere thereabouts around 22% as a margin and I think for a business that is north of $1 billion in annual revenue, I think there is plenty of room there.

Kirk Materne - Rafferty Capital Markets

Okay, great. Thank you very much.

Operator

We’ll hear next from Matt [Headburg] with RBC Capital Markets.

Matt Headburg - RBC Capital Markets

I am wondering, following up on an earlier question on international, Bob, you obviously talked about EMEA. Can you give us a sense for APAC, how that did in the quarter?

Robert E. Beauchamp

APAC did okay. They delivered in line with what we needed them to do. By the way, we had some great wins in Australia, particularly large financial services -- by the way, the company did really well in financial services, which is I think a strong testament to the value proposition because getting large ticket contracts from financial services companies, particularly -- many of them they are newspaper names is a statement that they see the value in them. And Australia did really well there too.

Matt Headburg - RBC Capital Markets

And then --

Robert E. Beauchamp

I was just in China, by the way, recently and I met with some of the largest IT organizations there and I can tell you what interestingly two of the very top IT people and two of the biggest companies in the world period, one financial services and one -- actually they were both financial services, said to me is that when we went through the BSM presentation, they said this is exactly -- they both said the same thing -- this is something that we have not done and this is exactly the time that we are looking to really focus on process optimization and how we really manage our IT in the process of managing IT, so we’ve got some really interesting engagements going with some very, very large companies in China that a few years ago, I think it was a little too early. So I am optimistic about what is going on there.

Matt Headburg - RBC Capital Markets

Good to hear. One last question in terms of the large deals you guys did a good job closing, the Q1 flip deals and closing all your big deals in Q2 -- can you give us a sense for just generically how long is it taking to close some of those deals, maybe on a year-over-year basis and then how do you think about that going into the second half of this year?

Robert E. Beauchamp

I don’t know that we have at our fingertips. If you call back, maybe we can -- I don’t know if we have any statistics on that or not, Steve, but specifically I would just say the difference that -- what happened that we saw when the economy finally did catch us was it wasn’t that -- it elongated all about a month, basically, and what normally was a -- took a week to finish up the paperwork started taking a month because there were other committees and other approval cycles and we just closed one of the world’s largest -- one of the largest private companies in all of the United States, one of the top two or three largest private companies just standardized on our offerings this quarter and that transaction could have easily closed at the end of last quarter but it had to go to another committee and another committee and I talked to the CIO who basically apologized and just said look, we’ve got new processes in place for transactions like this and it’s got to go through this extra hoop. So it adds a month or so, I’d say, on average.

Matt Headburg - RBC Capital Markets

Great, thank you, nice quarter.

Robert E. Beauchamp

All right, well, with that, let me just thank all of you for joining us. We appreciate your interest in BMC. There is a lot of opportunity for us to grow this company and we are excited about it and I want to thank the employees, some of whom I know are listening or will listen, for recreating this company into the strong platform company that it is today. So thank you all for joining us.

Operator

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

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