BMC Software F3Q07 (Qtr End 12/31/06) Earnings Call Transcript

TRANSCRIPT SPONSOR

BMC Software Inc. (BMC)
F3Q07 Earnings Call
February 8, 2007 5:00 pm ET

Executives

Bob Beauchamp - CEO
Steve Solcher - CFO
Derrick Vializ - VP of IR

Analysts

Inder Singh - Prudential
Sarah Friar - Goldman Sachs

Presentation

Operator

Good day everyone and welcome to today's BMC Software Third Quarter 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

Thank you, operator. I'm Derrick Vializ, Vice President of Investor Relations, and I would like to thank you for joining us today. Today's call is being webcast live and is also being recorded. An archive of the recording will be available this evening on 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/investor.

During our call, Bob Beauchamp, our CEO will provide an overview of our third quarter performance, and update on our Business Service Management strategy and then update on our mainframe business. After that, Steve Solcher, our CFO will provide additional financial and operational details. Bob will then provide guidance for the fourth quarter before we open the call to questions.

Before we continue, I would like to remind you that statements in this discussion including statements made during the question-and-answer session regarding BMC's future financial and operating results, the development of and demand for BMC's products, BMC's operating strategies, acquisitions, and other statements that are not 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 duty 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 each non-GAAP measure and the corresponding GAAP measure is provided in the tables accompanying the press release and in our GAAP to non-GAAP reconciliations found on our website at bmc.com/investors.

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

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Bob Beauchamp

Thank you, Derrick. BMC Software had an outstanding third quarter, with robust growth in our industry leading Business Service Management offerings, solid performance in our Mainframe business and good expense control.

Let me highlight a few key financial metrics during the quarter. Total bookings rose by 11% making this our second consecutive quarter of double-digit growth in total bookings. License bookings rose 18% and our core BSM license bookings increased 26%. We are clearly excited about the momentum we are building here. Core BSM license bookings have increased in the double-digits for three quarters in a row with growth accelerating to the 25% to 30% range in the past two quarters.

Revenues increased 9%, which is above our guidance. The 9% revenue increase was the largest we've seen in years. We are particularly pleased that the revenue increase was broad-based across product lines and all major geographies. License revenues increased in the mid teens for our ESM business and in the low double-digits for our MSM business. Our total maintenance revenues also increased in the mid single-digits. Overall, we had good revenue performance in the Americas, Asia Pacific and EMEA.

As you know, EMEA has been an area of particular focus for us and the management changes we've made during the course of the year are having a positive impact there. License revenues in EMEA rose by about 16% with strong performances in the UK, in Nordic region, Italy and Spain.

Our non-GAAP operating margin was 25%, up 6 percentage points versus a year ago period. Non-GAAP earnings per share was $0.41, an increase of 41% and above our guidance. This marks the seventh consecutive quarter that the company has met or exceeded our revenue and our non-GAAP EPS guidance.

Operating cash flow was $115 million, an increase of 72% compared to the year ago period. As you can see, we had a terrific third quarter and what is clearly shaping up to be a very good year. Underlying our solid performance is our success in capturing the growing demand for our Business Service Management solutions.

What's driving this demand? A couple of very important trends. First, as you know, IT budgets which consist of hardware, software, networks and IT labor costs are under constant scrutiny. IT labor costs which is a large component of IT spending is an area of particular focus. Companies are increasingly realizing that IT process automation helps them to improve quality and reduce errors, increase efficiency and save money, which they can then reallocate to fund technology driven innovation in their business models. That's where BSM comes in. BSM solutions can play a powerful role in two critical areas; first BSM helps companies improve IT efficiency by automating IT Service Management processes and workflows. It essentially takes what traditionally have been people-intensive processes and it standardizes them by leveraging ITIL best practices through ITSM applications. This enables companies to improve IT productivity and save money.

The second major benefit that BSM offers is greater alignment between IT and the business. The key here again is automating processes and workflows, in order to improve how IT shapes, responds and reacts to business decisions and challenges. That's the business case for BSM and it's a compelling one. It's driving an increasing number of companies around the world to transition to BSM and to BMC.

During the past quarter BSM customers included Dresdner Kleinwort, CNA, Charles Schwab, ING Bank, Siemens and Micron. The strength of our holistic BSM vision in integrated platform is also evident in the size and scale of the competitive replacements we are winning.

In the US, we had a major win with a large insurance company. They are implementing our Atrium CMDB and we replaced HP's Service Desk and Asset Management software, NetIQ Service Management Offerings and CA mainframe products. Another significant competitive replacement was in a global financial services company headquartered in Switzerland, which has adopted a broad suite of our ESM, MSM and DSM solutions and we'll also been implementing our Atrium CMDB as the centerpiece of BSM.

This is an important global win, in which we replaced product offerings from IBM and Hewlett-Packard. We are excited about the market's increasing acceptance of and evolution to BSM. While it's clear that the customer evolution is accelerating and that our demand is growing, it's still in the early stages. As the company that pioneered BSM, we have the most robust and comprehensive BSM solutions in the marketplace.

During the third quarter, we worked to extend our technology leadership around BSM. For example, we delivered new releases of our BMC Performance Manager and BMC Service Impact Manager product lines. These offerings enable customers to leverage our Atrium CMDB to manage their distributed systems environment and to better align it with their business needs. We believe these offerings will appeal to more than 2000 of our largest Remedy customers around the world and we'll be targeting those customers with these offerings.

As we move forward, our Distributed Systems Management business unit is focused on further developing and integrating our offerings to help customers reduce the cost of service, guarantee service level commitments and deliver business innovation.

Transaction Management continues to be an area of strong performance and significant opportunity for us. You will recall that last year, we identified Transaction Management as a strategic priority high growth market. Through the combination of internal development and the acquisition of Identify Software, we've responded to a key customer need, identifying, analyzing and resolving application related problems that affect transactions before they impact critical business services.

While we are pleased with our technology leadership, the improvements we continue to make in our go-to-market strategy are equally important to our performance. These include the transformation of our own sales-force, but more broadly it also encompasses the partnerships and alliances we've formed with leading systems integrators and other partners and vendors.

Our relationship with WebEx is a case in point. It aligns us with the leading provider of on-demand or software-as-a-service applications. It brings us a new sales partner for our Service Desk Express offering, that's highly experienced in selling into the small business segment. This is a new market focus for us.

As you can see, our go-to-market strategy is a multifaceted, multi-channel approach that encompasses traditional and emerging delivery models. It's designed to extend our reach and footprint and more effectively penetrate key market segments. It's enabling us to establish a growing flourishing ecosystem around BSM solutions that reinforce our leadership position.

Recently, we started a global marketing campaign, including advertising in leading business publications, like The Economist, The Wall Street Journal and BusinessWeek. It's designed to further increase the mindshare around BSM, as well as BMC. It reflects our belief that BSM is increasingly moving into the mainstream and now is the time for BMC to turn-up the volume.

Another measure of our leadership is reflected in the January 2007 Goldman Sachs IT Spending Survey. This study asks 100 IT executives from multinational Fortune 1000 companies, with strategic decision making authority, which software vendors are gaining or losing share of your IT spending. BMC once again is in the share gainers' column, moving up from seventh to third. In contrast, one of our major competitors is losing share.

I want to shift gears now and talk about our mainframe business. Most of you are aware of the market dynamics surrounding the mainframe business. Smaller enterprises have shifted away from the mainframe as reflected in the declining number of users. But among larger enterprises where we are focused, there has been a shift in favor of mainframes because of their stability, reliability and improvements to total cost of ownership.

Our view of the mainframe business is simple. We like the business. It's critical to our customers, large enough and stable enough to continue our investment and fund innovation. That was one of the drivers this year behind our decision to create a dedicated mainframe business unit. Our goal from a financial standpoint was to increase our share, stabilize bookings and revenue and improve earnings. Our mainframe business is an integral part of our strategy, BSM architecture, and vision. And this remains a key competitive advantage for us.

As you know, we are only a few quarters into this new business unit structure, but we like what we see so far. During the third quarter, we won 22 new MSM customers and saw good demand MAINVIEW and Enterprise Scheduling products. Major wins during the quarter include Alliance & Leicester, Assurant, EBD, and Westpac. So the enhanced focus we are bringing to the business is beginning to pay dividends in both R&D and in sales and marketing.

I am pleased to report that over the first nine months of fiscal 2007, Mainframe Service Management generated growth in terms of new customers, growth in total bookings and growth in revenues. We are on track to meet our annualized MSM bookings goal for fiscal 2007. That covers our ESM and MSM businesses.

Let me sum up by stating that we are optimistic about the overall state of our business. We had an outstanding third quarter and 2007 is shaping up to be a very good year for BMC Software.

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

Steve Solcher

Thanks Bob. Our performance this quarter continues to reflect the operating leverage in our business model. With revenues up 9% and non-GAAP operating expenses basically flat year-over-year, we increased non-GAAP operating income by 45%. Virtually all of the incremental revenue we generated year-over-year fell to the bottom line. As a result, we once again saw a significant improvement in our non-GAAP operating margin, which at 25% reached its highest level since the fourth quarter of fiscal 2000. For fiscal 2007, we expect to achieve a non-GAAP operating margin of 22%.

Let me turn now to discuss the quarter in more detail. I am going to begin by reviewing our operating results. Then I'll discuss bookings and the performance of each of our business units. After that, I'll cover revenues and operating expenses. Finally, I will conclude by discussing our balance sheet and cash flow from operations before turning the call back to Bob who will provide guidance for the fourth quarter.

Non-GAAP operating income was $102 million in the third quarter, an increase of 45% from a year ago. Non-GAAP operating margin was 25%, up 6 percentage points on a year-over-year basis. Non-GAAP diluted EPS was $0.41, up 41% compared to a year ago period. This reflects a non-GAAP effective tax rate for the quarter of 32% compared to our guidance of 29%. These non-GAAP results also reflect diluted shares outstanding in the third quarter of $210 million versus $218 million in the third quarter of fiscal 2006. Diluted shares outstanding have sequentially remained flat. During the quarter, our share repurchase activity partially offset options exercised and the increase in common stock equivalents.

GAAP operating income in the third quarter was $74 million, up 41% compared to the year ago period. GAAP net income and fully diluted EPS were $64 million and $0.30 compared to $49 million and $0.22 in the third quarter of fiscal 2006 respectively.

Turning to bookings, we had another strong quarter in both license bookings and total bookings. Total bookings of $433 million were up 11% compared to the year ago period. This marks the second consecutive quarter of total bookings growth over 10%. Total bookings for the 12 months ended December 31, 2006 were $1.58 billion, up slightly compared to the year ago period. The weighted average contract length for the 12 months ended December 31, 2006 was 2.3 years, flat compared to the year ago period. As a result, annualized total bookings for the trailing 12 months were $690 million, up 2% compared to the year ago period. This is now the fourth consecutive quarter in which we achieved annualized bookings growth on a trailing 12 month basis. Please refer to slide seven in our presentation. Particular strength in the third quarter came from license bookings which rose 18% in the quarter.

Now, let me turn to the performance of each of our business units. As you recall, we believe the MSM business unit is best evaluated on the basis of total and annualized bookings over the trailing 12 months. In the third quarter, total MSM bookings on a trailing 12 months basis were $661 million with an average contract length of 3 years. In the year-ago period, total MSM bookings were $707 million with an average contract length of 2.9 years. Total annualized MSM bookings for the trailing 12 months were down 10% to $220 million similar to that of the past several quarters.

However, if we look at the first three quarters of fiscal 2007, total annualized MSM bookings were roughly flat, compared to the year-ago period. We expect to achieve our full year fiscal 2007 goal for total annualized MSM bookings to decline by no more than 5%.

For ESM business unit, license bookings are the best measure of performance. Total ESM license bookings were $109 million in the third quarter, up 17% over the year-ago period. Within our ESM business unit, license bookings of our core BSM product group are a key indicator of the success of our Business Service Management strategy. Core BSM license bookings were up 26% in the third quarter. This is the second quarter in a row of over 25% license bookings growth.

Please see slide 8 of our presentation for historical license bookings growth.

Turning to revenues. Total revenues were $413 million, a 9% increase compared to the third quarter of fiscal 2006, and above our guidance for the quarter. License revenues in the third quarter were $155 million, an increase of 15% compared to a year-ago. We are pleased with the solid performance in North America, Europe and Asia Pacific.

Maintenance revenues in the third quarter of 2007 were $233 million, an increase of 4% compared to a year-ago. On a four quarter trailing basis, maintenance revenues of $909 million were up 4%. Professional services revenues were $25 million, up 17% year-over-year.

Moving to operating expenses, we had another quarter of solid expense management, non-GAAP operating expenses were $311 million, essentially flat with the year-ago period. Excluding the expenses from Identify Software, which we acquired last May, and the negative impact of currency, operating expenses were down 6%. I am pleased with the consistent operating expense discipline we have instilled in our business. This is the seventh consecutive quarter in which non-GAAP operating expenses had decreased or remained relatively flat on a year-over-year basis.

We are continuing to focus on improving key business processes throughout BMC. A number of operating groups within the company are working to reduce complexity, by implementing more simplified and standardized processes. We believe these initiatives will play an important role in making us a faster, more agile and efficient company; leading to enhance profitability and value creation for shareholders.

Now turning to the balance sheet. Total deferred license revenue at the end of the third quarter was $454 million, a record level; and an increase of $46 million on a sequential basis.

During the quarter we deferred 107 million of license revenues and released 62 million of deferred license revenues from the balance sheet. The percentage of license bookings that was deferred was 54% in the quarter, compared to 49% in the year-ago period. It is important to keep in mind that we grew license revenues 15%, despite deferring a higher percentage of license bookings. Total deferred revenue increased by $21 million sequentially, to $1.58 billion.

Software development cost on the balance sheet were $107 million, essentially flat with the second quarter of 2007. As we capitalize $15 million and amortize $16 million. Cash and marketable securities at December 31, were $1.4 billion, an increase of $40 million sequentially.

For the quarter, cash flow from operations was $115 million, up 72% compared to a year-ago. Adjusted cash flow from operations was 110 million up 90% compared to a year-ago.

For the 12 months ended December 31, 2006, cash flow from operations was up 9%. See slide 10 for a reconciliation of cash flow from operations to adjusted cash flow from operations.

During the quarter we repurchased 3.8 million shares for an aggregate value of $125 million. We have 404 million remaining under our current share repurchase program.

With that I will turn the call back over to Bob for his concluding remarks and guidance for the fourth quarter.

Bob Beauchamp

Thank you, Steve. I think it's clear that we are on track to deliver on all the goals we have outlined for you, revenue, operating margin, EPS and cash flow for fiscal 2007.

To remind you of those goals, at the beginning of the year we estimated non-GAAP EPS that excludes special items to be in the range of $1.22 to $1.32, assuming a 28% effective tax rate and we anticipated revenues to increase in the low to mid single-digits. We also expected to achieve a non-GAAP operating margin of 20% for the year.

Last quarter, we updated our forecast. We expected non-GAAP earnings per share to be in the range of $1.40 to $1.48 for fiscal 2007 using an estimated tax rate of 29%. We also estimated revenue growth in the mid single-digits and to exceed a non-GAAP operating margin of 20%. With our improved profitability in the third quarter, we are again raising our EPS guidance for the year. We now expect non-GAAP earnings per share will range between $1.45 and $1.49 for fiscal 2007. This assumes a tax rate of 30%. Non-GAAP excludes an estimated $0.45 of special items, including expenses for amortization of acquired technology and intangibles, stock-based compensation and restructuring.

We reiterate our expectation for fiscal 2007 revenue growth in the mid single-digits. We also reiterate our expectation to exceed a non-GAAP operating margin of 20% for the year, as we now anticipate that our non-GAAP operating margin will be 22% for the full year. We reiterate our cash flow from operations expectation to be between $400 million and $450 million and adjusted cash flow from operations to be between $475 million to $525 million. Adjusted cash flow from operations excludes an estimated $45 million negative impact from servicing receipts and $30 million in restructuring costs.

In terms of what this means for the fourth quarter of fiscal 2007; we anticipate fourth quarter revenues to range between $415 million and $435 million and non-GAAP EPS to be in the range of $0.36 to $0.40. This reflects an estimated tax rate of 30% and weighted shares outstanding remaining sequentially flat. Non-GAAP EPS excludes an estimated $0.10 of special items, including expenses for amortization of acquired technology and intangibles, stock-based compensation and restructuring.

Let me close by saying that we are very pleased by the progress we are making. Fiscal 2007 is clearly shaping up to be a year of very solid performances for our company. Our BSM strategy is gaining traction in the marketplace. The performance of our MSM business unit is on track. We are improving our business processes and our cost structure. We are looking forward to continue our strong performance during the fourth quarter in fiscal 2007 and to carry over this momentum into fiscal 2008.

With that, we will now take questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). We go first to Inder Singh with Prudential.

Inder Singh - Prudential

Yes. Good afternoon.

Bob Beauchamp

Good afternoon.

Inder Singh - Prudential

Congratulations on a solid quarter. It looks like bookings growth continues to accelerate and you seeming to control OpEx management at the same time as well.

Bob Beauchamp

Thank you.

Inder Singh - Prudential

I have a two-part question for you.

Bob Beauchamp

Okay.

Inder Singh - Prudential

On the first part, really getting into a bit of the BSM strength that we are seeing, the strength in bookings, the acceleration in bookings and sort of the migration from being overly depended on mainframe business and becoming more focused on BSM, how comfortable are you with the stabilization continuing on the mainframe and then the BSM momentum continuing? That's the first part. And the second part relates to the strong cash flow also that you seem to be throwing off. And whether this is something that you see as a blip or this is a trend that you expect to continue and may be strengthen as you go through this year and next year?

Bob Beauchamp

Okay. So, I'll take the first part and let Steve address cash flow. On the MSM, here's what I am confident of. I am confident that the new operating structure having a dedicated business unit is working. And that we should -- we do expect that unit to perform at significantly better levels than it has from previous years. We are executing better. There is more focus on it. There is a spring in the step of the team across all aspects, sales, marketing, research and development. And the whole leadership of that group is just doing a very solid job. All that said, I need to caveat by saying that mainframe is a lumpy business. And so, we certainly look at this quarter as there were some very nice large transactions in there. We expect next year -- we are going into next year with a good pipeline of deals in the pipeline for next year. But it will be a lumpy business and that's the only thing I would caveat it. Don't expect every quarter to be like Q3 of this year was.

Steve Solcher

And then, I am going to take the cash flow question and that is, if you look at this quarter at least for the quarterly number up 72% and for the nine month period, being up 29%. I think if you adjust for what are the timing effects of the servicing activity that we do -- for the full year, if you take the midpoint, we are going to probably be up 25% year-over-year and depending on how bookings go through in the next quarter, I would assert that cash flow should pretty much follow the line of bookings with a little bit of help coming from expense relief.

Bob Beauchamp

I will back up one second, Derrick pointed out to me that I didn't answer part of your question, which was around the BSM growth. There is no question that the BSM wave is large, sustainable and growing. We are seeing our competitors -- recently one of our competitors recently just had a press announcement and announced that they are now into the BSM business as well. I think everybody recognizes the way that BMC first announced and first began to address; back in three years ago is completely a real and large trend that's growing. We saw across the board, large customer standardizing on multiple products from BMC. I was on the phone yesterday with the CIO of a multibillion dollar home improvement supply company, retailer, who was explaining to me that he recognized that this was one of the biggest initiatives in his IT career for reducing his cost, improving reliability and really automating IT. And he was -- he captured the entire essence of BSM and that transaction when we did in Q2, and he was discussing with me about the optimism he has. He is actually ahead of schedule for ROI, he told me yesterday.

Inder Singh - Prudential

Thank you

Steve Solcher

Thanks.

Operator

We will hear next from Sarah Friar with Goldman Sachs.

Sarah Friar - Goldman Sachs

Good afternoon guys. Just a question around the operating expense expectations for next quarter, Steve, now that you just had a terrific operating margin, 25% in December, but if I kind of look at the guidance, you are definitely kind of caveating up that a little as we go into March. Where do you expect to spend more as we go into March, particularly since you have been more on a cost reduction mode rather than the cost increase mode?

Steve Solcher

Sarah, I would tell you that it is not a really spin mode on a year-over-year basis, I would guide you that it is actually going to decline. Where it is, is really the seasonal aspect of some of the expenses. So we have some calendar year expenses and that start January 1st, there is some reloads, 401-K, payroll taxes, as well as the timing and the nature of some of our other seasonal expenses, which are more related to fiscal yearend expenses which are variable comp related. So it just -- it's going to follow a similar pattern as last quarter, I mean last year this same quarter in the fourth quarter, so you should expect to see the same sequential move, but year-over-year it will be down.

Sarah Friar - Goldman Sachs

In the same vein, as you think about your cost structure looking forward, are you still in big cost reduction mode or are you really looking to optimize processes and take out cost from the organization? Or are we a bit more back into growth mode again?

Bob Beauchamp

Sarah, this is Bob. We have a -- the strategy that we announced internally for optimizing our processes, was started in April of last year, is still in full bloom. We are -- we still have at least another full year of work that we believe, where we can improve efficiency, improve productivity, doing all this without taking away growth opportunities. In fact we are going to spend more money on key areas in this company this year. We will spend more money on advertising. We will spend more money in some of the key new product areas this year. We will spend more money in IT, in some investments on automation. So, we are -- it was a redirection or reprioritization and as well as streamlining that we went through, and we are halfway through it.

Sarah Friar - Goldman Sachs

Thanks. Okay, that's helpful. Thanks a lot.

Operator

(Operator Instructions). And it appears that is all the time we do have for questions. Mr. Beauchamp, --

Bob Beauchamp

Operator, let me just ask you to make sure there is not a technical problem. That would be unusual for us to only have two questions, and maybe that the numbers were good enough, they speak for themselves. But let's just ensure that we have all the questions answered.

Operator

(Operator Instructions). And there appear to be no further questions.

Bob Beauchamp

Alright. Well let me just summarize, if I may as follows. Revenues up 9% year-over-year, non-GAAP operating margin up 6 full points to 25%, EPS up 41%, cash flow from operations up 72%, raise in guidance, total bookings up 11%, license bookings up 18% core BSM license bookings up 26%, ESM license bookings up 17% and the mainframe business that's growing on multiple fronts; all that being done while we are controlling expenses and retooling the organization for a long-term better run and more efficient company. I want to thank the employees at BMC, thank our customers, and thank our shareholders for joining us today.

Operator

That will conclude today's conference call. You may now disconnect and have a pleasant day.

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