CA F2Q07 (Qtr End 9/30/06) Earnings Call Transcript

Executives

Sam Pattanayak - VP of IR

John Swainson - President and CEO

Nancy Cooper - CFO and EVP

Mike Christenson - COO

Analysts

John DiFucci - Bear Stearns

Sarah Friar - Goldman Sachs

Bryan McGrath - Credit Suisse

Robert Stimson - WR Hambrecht

Walter Pritchard - Cowen & Company

Philip Olsen - UBS

Eli Lap - Phil and Reed

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CA Incorporated (CA) F2Q07 Earnings Call November 2, 2006 5:00 PM ET

Operator

Good afternoon, my name is Bobbie and I'll be your conference operator. At this time I would like to welcome everyone to the CA Second Quarter Fiscal Year 2007 Financial Results Conference Call. All lines have been placed on mute to prevent background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions) Thank you, Mr. Sam Pattanayak, You may begin your conference.

Sam Pattanayak

Thank you operator and good afternoon everyone. This is Sam Pattanayak, Vice President of Investor Relations at CA. The purpose of today's call is to discuss our second quarter fiscal 2007 results. Joining me are John Swainson, our Chief Executive Officer; Nancy Cooper, our Chief Financial Officer and Mike Christenson, our Chief Operating Officer.

As a standard procedure, let me read our Safe Harbor provision. This conference call is being broadcast over the phone and via a live webcast open to all interested parties. All content is a property of CA and is protected by US and international copyright laws and may not be reproduced, transcribed or produced in any way without the express written consent of CA. We consider your continued participation in this call to be consent to our recording.

During this call, non-GAAP financial measures will be discussed. Reconciliations to the most directly comparable GAAP financial measures are included in the earnings release and supplemental financial information package, both of which are available on our website at investor.ca.com.

Today's discussion may contain forward-looking statements. Consistent with all of our public statements, there can be no assurances that these forward-looking statements will prove accurate and the actual results could differ materially from forecast and estimates. Please refer to our SEC filings for further elaboration of the risks involved. In accordance with SEC regulations, all featured guidance and material information will be publicly disseminated to any interested party. Now let me turn the call over to John.

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John Swainson

Thank you, Sam. Good afternoon, everyone and thanks for joining us on our second quarter earnings call. You'll hear from Nancy Cooper, our CFO in a few minutes. Mike Christenson, our COO will join us for question and answer. Before Nancy takes you through a detailed review of our financials, let me start by giving you the topline on our performance in the second quarter, and address the challenges we faced in that quarter, the actions we have taken to address them and the outlook for the second half of the fiscal 2007.

So, let's get started. Our second quarter total revenue, GAAP EPS and non-GAAP EPS were at or above our expectations. In the first quarter, bookings and billings were above last year's levels but in the second quarter we made a number of changes to our sales organization which affected our business activity and consequently reduced both our bookings and associated billings. While this lower than anticipated level of bookings and billings hurt our cash flow in the quarter, changes in working capital, including a lower cash collection rate and higher accounts payable dispersements were the primary factors in the decline of our second quarter cash flow from flow operations compared with last year.

We believe that we have addressed the issues that affected our performance in the second quarter and we're confident in our ability to execute in the second half. However, this does have an impact on our full-year outlook for cash flow from operations which will be lower than expected.

As I have said before, we're in a multi year transformation of CA. As part of this process of transformation, we're looking at every aspect of our operations and making changes to our critical business processes. We started to refocus our US sales organization on relationship and solution selling last year and after reviewing the results, decided to accelerate the process and take it worldwide. It will have a short-term impact, but we completed this transition in the second quarter and believe we will see benefits starting immediately. And we're continuing to make significant progress in the other parts of our transformation.

Our development and marketing teams recently launch Unicenter 11 on Microsoft SQL Server database. This marks a significant release of CA's flagship Enterprise Management Solution and combined with the other market-leading products from our recent acquisitions and updates to all of our product family gives us the best product portfolio in CA's history. Second, we're continue to go address CA's need for best-in-class business systems and business processes that will ensure compliance and generate superior business intelligence for our organization. Our ERP implementation is on track. This will be the second quarter with SAP online in North America.

Third, as previously announced our restructuring is well under way and we are on track with our plans to reduce our operating structure and take out cost that we expect to result in a $200 million annualized savings by the end of fiscal 2008. And finally, in the second quarter, we completed a critical step in our transformation, which was the previously mentioned realignment of our sales organization.

Let me take you through some of the highlights of the sales organization change. We more than doubled the number of customer facing sales people to create stronger customer partnerships. This group is focused on selling new solutions to new and existing customers in a more systemic and disciplined way. We've aligned our 1500-plus technical sales organization, around our key growth products and solutions. At the same time we have established a core group of sales people that are exclusively focused on managing, maintaining and renewing our install business and we're focusing our direct sales organization on our 5,000 most important enterprise accounts and covering the balance of the market with our channels organization.

We've simplified our sales commission plan with clear incentives to drive new product sales and renewals. We're making significant investments in sales force training and, finally, we're aligning our marketing resources behind solution sets and key product launches. This sales force realignment was a significant undertaking which we completed in a relatively short period of time in the second quarter and so far the feedback we received from that sales organization has been positive.

Now, let me turn to our share repurchase plan. As you know, in the second quarter, we completed our $1 billion tender offer and repurchased 41.2 million shares, bringing our total share repurchases this year to 51.1 million shares. Nancy is going to provide you with an update of the remaining portion of our share repurchase program in a few minutes.

Let me close with our full-year outlook. Going forward, we continue to be optimistic about the strength of our business. This combined with a great market opportunity and a good environment for software spending makes us confident that we're on track to show good economic performance in the second half of our fiscal year. Our original plan for cash flow from operations from the second half was around $900 million to $1 billion, and that is the level we believe we'll deliver for the full fiscal year. And we expect to meet or exceed our previous outlook for total revenue of $3.9 billion and non-GAAP operating earnings per share of $0.83.

With that I will turn it over to Nancy.

Nancy Cooper

Thanks, John. I'll start by reviewing second quarter financials and then provide you with more details on the restructuring program and outlook. Total revenue in the second quarter was $996 million, up 5% from a year ago, and was primarily driven by the growth in subscription revenue. From a geographic perspective, North American revenue was up 8% and revenue from international operations was up 1%, including about a $15 million benefit from foreign exchange. Second quarter subscription revenue was $762 million, up 8% from a year ago. Subscription revenue accounted for 77% of total revenue in the quarter, compared to 74% in last year's second quarter.

Total expenses for the second quarter were $918 million versus $893 million in the second quarter of 2006. The increase of $25 million was primarily attributable to higher SG&A costs of $42 million, driven principally by expenses associated with personnel cost and recent acquisitions. Remember, that while we take the expenses from our acquired companies in the current period, much of the revenue will be typically deferred over time under our rateable recognition model.

Other expense increases include $15 million from cost of professional services and $5 million from higher royalties and bonuses. These expense increases were partially offset by $23 million in lower amortization and depreciation and a $14 million gain on the sale of marketable securities. GAAP net income was $53 million for the second quarter or $0.09 per diluted common share, compared to net income of $46 million or $0.08 per diluted common share in last year's second quarter. Non-GAAP net income was $145 million for the second quarter or $0.25 per diluted common share, compared to $151 million or $0.25 per diluted common share in last year's second quarter.

A reconciliation of GAAP to non-GAAP results is contained in the earnings press release. Second quarter bookings for total products and services declined 10% to $690 million. A shortfall in bookings relative to last year's second quarter and to our expectations can primarily be attributed to a decision to realign and restructure the sales force to achieve lower cost of sales and higher productivity, and a more disciplined approach on contract renewals.

Direct product bookings declined 13% to $498 million and indirect bookings grew 3% to $75 million. It is important to note, as we've said before, that bookings on a quarterly basis tend to be volatile, and can be significantly affected by many factors, including large transactions. For the first half of fiscal 2007, total bookings of $1.25 billion were flat year-to-year.

We expect to have total bookings to grow on a full year basis. Let me address billing. Billings were 860 million, a decrease of 12% over the 975 million reported in the prior year period. Billings were negatively affected by a lower level of bookings in the second quarter.

For the fiscal first half, billings were relatively flat compared to last year, but below our plan. Additionally, there were no significant differences in the value of large contracts billed upfront in the second quarter when compared with last year's second quarter and in total are less than 5%. Now, I'll turn to the cash flow statement. Second quarter cash flow from operations was $6 million, compared to $299 million in last year's second quarter. For the first half of this fiscal year, cash flow from operations was negative $40 million compared with $392 million generated in the comparable period last year. This reduction in the first half of the year is driven by a number of one-time items which account in total for approximately 70% of the difference.

Now, let me walk you through the significant one-time items. First, an approximate 240 million difference from the prior year's first half is from the change in working capital as we experienced an unanticipated increase in our receivable cycle as well as a reduction in our payable cycle. We expect to return to more normal levels of collections in the second half of the year and we have already invested more into our payables than we had originally intended for the year.

Second, approximately $45 million was related to higher fiscal 2006 commissions paid in fiscal 2007. Third, approximately $36 million was a result of our contribution to our 401-K plan which we historically made in the fourth quarter of the prior year and, finally, approximately $34 million was attributable to higher payments related to restructuring. Partly offsetting those items, we had a 75 million restitution fund payment made in the second quarter last year, which we did not make this year.

Again, these were the cash flow one-timers. The balance of the difference in cash flow in the first half is primarily a result of business operations, including approximately $130 million from an overall higher level of expenses, mostly due to prior-year acquisitions, and the fact that our new restructuring program was only initiated in mid-August. Of course, we had planned for higher bookings in the first half, to cover some of these increased costs and some of the payables.

Turning to the balance sheet, we ended the quarter with $1.3 billion in cash and equivalents and $2.6 billion of total debt. So, our net debt is 1.3 billion.

Now, let me address the restructuring program we announced during our first quarter conference call. This program is well under way. In the second quarter we recorded restructuring costs of $39 million, relating to approximately 750 positions, of which $11 million was paid in cash during the period. We now anticipate a reduction in the work force of approximately 1400 positions, and also expect to eliminate an additional 300 positions, through attrition. We currently expect total restructuring charges of approximately $150 million, down from our previous estimate of $200 million. Most of these charges will be recognized in fiscal 2007.

Despite the reduction in restructuring charges, we are on track to deliver $200 million in annualized savings by the end of fiscal 2008. Now, I will provide you with the details of our updated outlook for full-year fiscal 2007. We expect to meet or exceed our previous outlook for total revenue of $3.9 billion. We also expect to meet or exceed our previous outlook for non-GAAP operating earnings per share of $0.83. Two points of clarification: this EPS outlook has always included the benefits we expect to realize from 2007, related to a restructuring program of about $30 million. It did not include higher interest expense as well as lower share count from funding our recently completed billion-dollar tender offer which was saluted diluted in '07 but will be accretive in '08.

We expect cash flow from operations of between $900 million to $1 billion, down from the previous outlook of $1.3 billion. The new cash flow outlook includes bookings growth for the full year, although not at the levels originally planned, and an improvement in collections. Furthermore, this outlook includes borrowing costs associated with the tender offer and a payment associated with the 20007 restructuring plan, which was not included in the previous cash flow outlook.

As of today, we also anticipate about $570 million in average diluted share count in fiscal 2007, and a non-GAAP tax rate of 33%. Now, let me address share repurchases. As John said, we completed our billion-dollar tender offer in the second quarter. In total this fiscal year we have repurchased 51.1 million shares at a cost of $1.2 billion, which accounts for a 9% reduction of outstanding shares. Additionally, we anticipate spending about $88 million this year in dividend payments.

With respect to the remaining portion of the share repurchase program, we are exploring options and we will update you on the timing and method at the appropriate time. However, we want to see our performance meeting our expectations, a return to strong cash flows, and favorable market conditions before we move forward. And now with that, I'd like to turn the call back to John.

John Swainson

Thanks, Nancy. Before opening the lines for Q&A, let me summarize the quarter and where we stand in our business. While second quarter total revenue and non-GAAP EPS were on or ahead of plan, we clearly saw an impact on our bookings and cash flow in the second quarter. Our restructuring program is on track. We're taking the steps to realize the $200 million of annualized savings from operational expenses by the end of fiscal 2008, and, finally, we believe our sales related issues are behind us. Our sales organization realignment is complete. As a result we are optimistic in our ability to execute in the second half of the year and furthermore believe we're well positioned to grow in the future. With that, we'll now open the lines for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions). We will pause for just a moment to compile our Q&A roster. Your first question comes from the line of John DiFucci with Bear Stearns.

John DiFucci - Bear Stearns

Thank you. Nancy, first question has to do with the remaining $1 billion repurchase. We understand you're exploring options there. But do you still intend to do that by March 31st, which was, I think, the last press release that mentioned it or I believe it was June 30th, it was actually mentioned in the 8-K that actually went out.

Nancy Cooper

John, what I was trying to communicate, we will continue to update you on this business, but at this time exploring options means we can't give you a specific date. Obviously we would like to see our performance return to our expectations on cash flows and favorable market conditions. So, with those three it is hard to pinpoint a date, although you can see that we'll be considering it actively going forward.

John DiFucci - Bear Stearns

Okay. Okay. One other question on the revenues, it sounded -- it looked like international was on a constant currency basis actually down year-over-year. Is there any specific regions that were particularly week internationally?

Nancy Cooper

No, I would say your assessment is right particularly and it is jus slightly down.

John DiFucci - Bear Stearns

Okay. And one last question for John; John, obviously you guys are working through a lot of issues here, and you had the restructuring, you expect that to get full benefit by the end of 2008 but you have talked about how the sales force is righted. I'm just wondering, is this next quarter the quarter where we're going to see a big improvement here over two quarters that are arguably some of the -- couple of the toughest quarters CA has seen in a very, very long time?

John Swainson

I hope so.

John DiFucci - Bear Stearns

Okay. Thanks.

Operator

Your next question comes from the line of Sarah Friar with Goldman-Sachs.