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BMC Software (NASDAQ:BMC)

Q1 2012 Earnings Call

July 27, 2011 5:00 pm ET

Executives

Stephen Solcher - Chief Financial officer and Senior Vice President

Derrick Vializ - Vice President of Investor Relations

Robert Beauchamp - Chairman, Chief Executive Officer and President

Analysts

S. Kirk Materne - Evercore Partners Inc.

Matthew Hedberg - RBC Capital Markets, LLC

Robert Chen - Citigroup Inc

Michael Turits - Raymond James & Associates, Inc.

Kevin Buttigieg - Collins Stewart LLC

Sitikantha Panigrahi - Crédit Suisse AG

Operator

Good day, everyone, and welcome to today's BMC Software First Quarter Fiscal Year 2012 Earnings Results Conference. Today's program is being recorded. At this time, for opening remarks, I'd like to turn things over to Mr. Derrick Vializ. Please go ahead, Derrick.

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 both the first quarter fiscal 2012 performance of our company and business units and update you on recent initiatives.

After that, Steve Solcher, our CFO, will provide additional financial and operational details. Bob will then discuss and provide an update to our expectations for fiscal 2012 before we open the call to questions.

These 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 investors.bmc.com.

Before we continue, I would like to remind you that the statements in this discussion, including statements made during the question-and-answer session, regarding BMC's future financial and operating results, particularly statements and views regarding the remainder of fiscal 2012, 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 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 measures is provided in the tables accompanying the press release and at investors.bmc.com. Now, I'll turn the call over to Bob.

Robert Beauchamp

Thank you, Derrick, and thanks to all of you for joining us this afternoon. You've seen our first quarter results in the press release we issued earlier today. Our overall performance was solid with strong increases in bookings, revenue, non-GAAP earnings and cash flow from operations. While ESM license bookings were flat, we saw continued growth in key business initiatives, including our Cloud, Software-as-a-Service, Professional Services, and MSM Solutions. Some highlights during the quarter.

Total bookings rose 39%. License bookings were up 43%. ESM license bookings were flat although the prior year period was a quarter in which they rose 40%. MSM trailing 12-month bookings were up 25%. Revenue grew 9%. Non-GAAP operating income rose 9%. Non-GAAP diluted EPS was up 16%, and operating cash flow was up 56%.

Now let me provide some additional perspective on our 2 business units beginning with ESM. ESM license bookings were flat in the first quarter and below our expectations. This reflects several factors. Most importantly, we had a difficult compare with the first quarter last year, a period in which we generated 40% growth in ESM license bookings. Contributing to that 40% growth last year were 4 large ESM license transactions, each of which were more than $3 million in license bookings, this included a $15 million transaction from the prior quarter, which was closed minutes into the fiscal 2011 first quarter.

This quarter by contrast, we only had one ESM licensed transaction over $3 million. I want to highlight that while we had fewer ESM license transactions over $3 million, we had a healthy increase in ESM license transactions over $1 million with 20 this year versus 14 a year ago. In addition for license transactions under $3 million, ESM license bookings increased 25% year-over-year.

In addition to the lack of large deals this quarter, we saw weakness in the U.S. Public Sector during the quarter. Finally for some of our larger transactions, we're seeing in selected cases, an elongation in the selling process, especially in Europe, as customers take longer to evaluate the strategic investments they're making.

Some customers, for example, are inserting additional approval steps into the buying process. We saw that this last quarter. So to summarize, these factors, a tough compare, fewer larger transactions, some public-sector weakness, and a longer sales cycle, contributed to our ESM license bookings performance this quarter. Despite these challenges, our ESM business continued to capitalize on the opportunities resulting from key technology trends. Our Cloud and Software-as-a-service initiatives gained more traction in the marketplace, and we won a number of additional customers around the world.

In fact, during the first quarter, we had 21 Cloud Solutions wins. These include NBC Universal, University of Hong Kong, and Bezeq International, which is Israel's leading Internet and International telecommunications provider.

In the same time period, we saw a 53% increase in the number of SaaS wins from our Remedy OnDemand and RemedyForce offerings. New SaaS wins during the first quarter included MIT, News International, Houston Independent School District, and the Open University. New wins during the quarter included Commonwealth of Pennsylvania, Micron Technology, Nordstrom, and Telstra.

Due in large part to the increased demand for cloud implementations, our professional services revenue rose 35% for the quarter and profitability improved. To help take our services organization to the next level of performance and delivery, we've hired a new VP of Global Services, Carlos Granda. Carlos is an experienced professional services executive who had leading roles at VMware, Oracle, and BEA Systems. We expect him to drive continued growth and operational excellence in services.

We're also continuing to invest in our sales force. The number of sales reps that we hired in the first quarter increased on both a sequential and year-over-year basis. Due to a more competitive market for talent, we are a bit below where we'd like to be for hiring. Therefore, we now expect average productive sales headcount to be up closer to 10% for the fiscal year, compared to our original expectation of high teens. We plan to continue to hire aggressively in the second quarter.

The need for flexible, agile IT infrastructures remains high among enterprises. We continue to stack up very well against the competition and have seen no change in our competitive positioning. I want to add that based on what we see in the marketplace and our pipeline, we remain positive about the rest of the year. We are not seeing signs of a broad-based slowdown in spending on IT.

While we remain positive about our outlook and competitive position, we are revising our fiscal year 2012 expectations for ESM license bookings growth from the low 20s as discussed in May to the mid-teens. This revised expectation reflects the lower number of productive sales headcount, negative currency impact on growth versus prior expectations, continued weakness in the public sector, and some elongation of the sales cycle for very large transactions particularly in Europe.

Let me turn now to our products and our alliances. To enhance our technology leadership, we launched an important new portfolio of solutions that delivers the industry's most robust application performance management capabilities across physical, virtual, cloud and hybrid environments. These new solutions leverage our recent acquisition of Coradiant, which significantly enhanced our EPM capabilities.

We also recently acquired Aeroprise, which provides the most widely deployed mobility solutions for our remedy IT service management suite. We continue to expand our partnerships and alliances, announcing new strategic partnerships with Red Hat, and Unisys and continued the momentum of strong relationships with Cisco, Salesforce.com, Accenture, and others. I encourage you to review the progress we've made in this area found on our website at BMC.com/partners.

Let me now turn to our MSM business, which had a very strong performance during the quarter across the business as well as one large renewal.

Total MSM bookings for the trailing 12 months increased 25% to $990 million dollars. Total annualized MSM bookings for the trailing 12 months were up 15%. We continue to see strong double-digit growth in the annual spend rate of our top 15 MSM transactions in the first quarter. During the quarter, we added 51 new product placements in our existing install base. Further we expanded our relationship with customers like Federal Express, Medicare Australia, and Nissan.

We also added 4 new MainView customers, including FedEx, replacing the competition in each instance. We saw continued strength in workload automation which includes our BMC Control-M product line. Workload automation is about 1/3 of our MSM business. We added 26 new BMC Control-M customers and expanded our existing relationships with 37 new product placements.

Some key workload automation wins for the first quarter included Wendy's International and Hong Kong Electric Company. We believe the mainframe business continues to offer very good opportunities for us. In fact, we recently acquired the portfolio of IMS database products and customers from Neon Enterprise Software. The deal further enhances our IMS database management portfolio providing the most comprehensive solution set to best address today's IT challenges with big data, database availability, and data analysis all within organizations' IMS environment. So that gives you a snapshot of our performance in key developments in the first quarter.

Let me wrap up my initial comments with a few important highlights. First, our market opportunity remains very strong. We believe there are important opportunities ahead for BMC to leverage its leadership in IT management as technology trends such as cloud computing drive customer purchasing decisions.

Second, we are continuing to invest in our business to enhance that technology leadership. That means developing new products internally, acquiring new capabilities, tightly integrating them into our portfolio, and partnering with other industry leaders to bring our solutions to market.

Third, our management team is committed to and focused on executing our strategy for growth. We recently made a key leadership change towards this end. I'm extremely happy to report that Paul Avenant, who headed up ESM products and marketing, has been promoted to Service President of our ESM business. Paul's leadership and operational skills have contributed greatly to our success over the past several years. I'm confident that under Paul's oversight, ESM will expand its market leadership in technology, sales, marketing, and operations.

So in short, we have the market opportunity, the technology and the leadership in place for continued success. This success depends in large part on our ability to execute in a high-level and on a consistent basis. Based on what we're seeing today, our outlook for the remainder of the year continues to be quite positive. I'll provide you with our updated expectations for fiscal 2012 in a few minutes. But first, Steve Solcher will provide a more detailed financial review of the quarter.

Stephen Solcher

Thank you, Bob. In the first quarter, we had strong financial performance and year-over-year growth across most of our key metrics, including total bookings, revenue, non-GAAP earnings per share and cash flow from operations. Our MSM business had a very solid quarter and strong growth on a trailing 12-month basis.

While our ESM license bookings were flat year-over-year, we continued to see momentum across key areas of this business including cloud, Software-as-a-Service and Professional Services. We remain positive on our outlook for the fiscal year.

Although margins were flat year-over-year, it is important to point out that we had a $6 million headwind in the first quarter relating to more amortization of software capitalization, and we expect to have a similar headwind in the second quarter. In addition, our license bookings ratable rate was 11 percentage points higher this quarter than in the prior period, driven by a higher dollar percentage of term based transactions.

With those thoughts in mind, let me now turn to our financial results. Non-GAAP operating income increased by 9% from $157 million to $171 million in the first quarter. Our first quarter non-GAAP operating margin was 34%, flat with the year ago quarter. Please refer to Slide 5 in our presentation for selected non-GAAP financial information, which includes segment profitability of our ESM and MSM business units.

ESM's non-GAAP operating income in the first quarter was $59 million, down 9% from the year ago period. ESM's non-GAAP operating margin declined year-over-year by 4 percentage points to 19%. As Bob mentioned earlier, we continue to make strategic investments in our ESM business unit.

MSM's non-GAAP operating income in the first quarter was $111 million, up 22% from the year ago period, and its non-GAAP operating margin increased 5 percentage points to 57%. We remain focused on maintaining strong operating margins within our MSM business unit.

Our non-GAAP net earnings for the first quarter were $129 million, up 14% from the first quarter of fiscal 2011. Non-GAAP diluted earnings per share for the period was $0.72, which reflects a non-GAAP effective tax rate of 23% for the quarter. These non-GAAP results reflect diluted shares outstanding in the first quarter of $181 million versus $184 million in the year ago period.

GAAP operating income in the first quarter was $115 million compared to $108 million in the year ago period. GAAP net income and diluted earnings per share were $96 million and $0.53 per diluted share compared with $93 million and $0.50 per diluted share in the first quarter of fiscal 2011, respectively.

First quarter GAAP net earnings in fiscal 2012 and 2011 were positively impacted by net income tax benefits of $6 million and $14 million, respectively, in which we recorded in connection with tax authority settlements related to prior year tax matters. These tax benefits were excluded from our non-GAAP results.

Turning now to bookings, total bookings for the first quarter were $615 million, representing an increase of 39% compared to the year ago period. On a constant currency basis, first quarter bookings increased 33%. Our bookings growth was positively impacted by a large multi-year transaction that was primarily a renewal within our MSM business.

Total license bookings for the quarter increased by 43% year-over-year to $193 million. The weighted average contract length for total bookings on a trailing 12-month basis was 2.42 years, up 11% from 2.19 years in the year ago period.

After normalizing for contract length, trailing 12-month annualized bookings for the first quarter were $978 million, up 7% from the year ago period. Please refer to Slide 7 in our presentation.

Now let me turn to the performance of each of our business units. In the first quarter, total ESM license bookings were $101 million, flat with the year ago period. We see a solid pipeline entering the second quarter and expect similar sequential growth as with the prior year, as well as year-over-year growth in the second quarter.

Turning to the MSM business unit. Total MSM bookings for the trailing 12 months increased 25% to $990 million and had an average contract length of 3.3 years. On a constant currency basis, trailing 12-month MSM bookings were up 23%. Again, MSM bookings and the average contract length were impacted in the quarter by a large multiyear renewal. After normalizing for contract length, total annualized MSM bookings for the trailing 12 months were up 15% as reported and 13% on a constant currency basis to $301 million.

Turning to revenue. Total revenue for the quarter was $502 million, a 9% increase compared to the first quarter of fiscal 2011. On a constant currency basis, revenue increased 7%. License revenue in the first quarter was $190 million, up 11% from the year ago. ESM license revenue was $119 million, up 5%, while MSM license revenue was $71 million and up 22% from the first quarter last year.

For the first quarter, maintenance revenue was $265 million, an increase of 4% compared to the year ago quarter and up $6 million sequentially. ESM maintenance revenue was $141 million, up 3%, and MSM maintenance revenue $123 million, up 6% compared to the first quarter of fiscal 2011. We are pleased with both the sequential and year-over-year growth and maintenance revenue across both our business units.

Professional Services revenue, which is included in the ESM segment, grew 35% from the year ago period, to $48 million in the first quarter. This business delivered a non-GAAP gross margin of 5%. We remain pleased with the transformation we are making in our Professional Services organization.

Moving next to operating expenses. Non-GAAP operating expenses for the first quarter were $332 million, up 9% from the year ago period. On a constant currency basis, non-GAAP operating expenses were up 5% year-over-year. Looking at our business units, ESM's non-GAAP operating expenses for the first quarter were $249 million, up 13% from the year ago quarter. This increase reflects the impact of currency and the strategic investments we made in our ESM business, as we increased our expense run rates from acquisitions, added additional sales and services capacity, and accelerated our internal development efforts around cloud and Software-as-a-Service.

MSM's non-GAAP operating expenses were $83 million, flat compared to the year ago quarter. Other income in the first quarter was a loss of $2 million compared to a loss of $6 million in the year ago quarter.

Now turning to the balance sheet, total deferred license revenue at the end of the first quarter was $689 million, up slightly sequentially and up 17% year-over-year. During the quarter, we deferred $106 million of license revenue, or 55% of license bookings, and recorded $104 million of deferred license revenue from the balance sheet.

Total deferred revenue increased by $113 million sequentially to $2.1 billion. The current portion of deferred revenue now stands at 52%. Our net capitalized software development cost were $202 million, a 4% increase over the fourth quarter of fiscal 2011, as we capitalized $31 million and amortized $23 million.

For the year, we continue to expect net software capitalization to be down $20 million over the prior year. Cash and marketable securities at June 30 totaled $1.7 billion, a decrease of $78 million sequentially. Our net cash position was $1.3 billion at June 30. For the quarter, cash flow from operations was $261 million, up 56% from the year ago period. Cash flow for the first quarter was positively impacted by strong intra-quarter collections.

By the end of the first half of fiscal 2012, we now expect to have approximately 43% of our full-year expectations for cash flow from operations. This is 5 percentage points higher than last year.

During the first quarter, we repurchased 3.4 million shares of our stock for a total cost of $180 million. We now have $450 million remaining in our current share repurchase program as of June 30. We also spent $151 million related to the acquisitions of Coradiant and Aeroprise, and the IMS assets for Neon Software.

Let me briefly sum up. From a total bookings, non-GAAP earnings per share and cash flow perspective, our first quarter was strong. Our MSM business performed very well. While ESM license bookings were flat from a difficult comparison, our ESM business saw positive trends in key growing markets such as cloud and Software-as-a-Service.

Our outlook for the remainder of the year remains positive. With our leadership position in key growth areas, and the strategic investments we are making through both internal development and acquisitions, we are well positioned to capitalize on the market opportunity ahead of us.

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

Robert Beauchamp

Thank you, Steve. I'd like to close by updating you on our view of fiscal 2012. As we have noted, we expect the remainder of fiscal 2012 to be a period of strong growth, particularly in the latter half of the year for ESM license bookings.

We believe that the drive by enterprises to create more flexible, agile, IT infrastructures is generating strong demand for our portfolio of integrated technology solutions. We're continuing to invest in higher growth, higher return areas of opportunity to enhance our leadership in the marketplace.

In terms of the fiscal 2012 outlook, we now expect non-GAAP diluted earnings per share in the range of $3.25 to $3.35 per share, which is $0.04 higher than our previous expectations provided in May. At the midpoint, this would represent a 10% increase over last year. This includes approximately $0.02 dilution related to Coradiant.

This range excludes an estimated $0.92 to $0.97 a share for non-GAAP adjustments, including expenses related to the amortization of intangible assets, stock-based compensation and severance, exit cost and related charges.

The assumptions underlying this full year fiscal 2012 estimate include total bookings growth in the low double digits, with a SKU of full-year booking expected in the first half of the year to be similar to the prior year. ESM license bookings growth in the mid-teens. MSM total bookings growth in the high single digits, which is higher than our previous expectations of the mid-single digits.

Revenue growth in the high single to low double digits, operating margin flat with the prior year, an increase in the license bookings ratable rate in comparison to prior year, currency impact at today's rates, which is a negative impact of about 1 point to the total bookings and revenue growth rates compared to our previous expectations, other income at a loss of approximately $8 million for the year, weighted shares outstanding slightly lower than fiscal 2011, and a non-GAAP tax rate of 24% for the year.

We continue to expect the full year fiscal 2011 cash flow from operations to be between $825 million and $875 million, which represents an 11% improvement over fiscal 2011 at the midpoint. With that, we will now turn the call over to questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] We'll go first to Phil Winslow with Crédit Suisse.

[Technical Difficulty]

Operator

Hearing no response, we'll move next to Kevin Buttigieg with Collins Stewart.

Kevin Buttigieg - Collins Stewart LLC

Within the ESM business, I understand what you're talking about in terms of the comparisons in Europe. Europe actually, or international I should say, look quite strong for you there. Was there something to the performance in Asia Pacific, or was that mainframe driven, or is there anything that you could -- any further light you could shed on that performance there?

Robert Beauchamp

So Europe revenue was strong, but bookings were not as strong in Europe. We did very well in Asia Pac. Asia Pac was actually a real bright spot in terms of growth. We did really well in China. We had, I think, the best quarter ever in Australia, New Zealand. So Asia across the board really had really good solid performance for us.

Kevin Buttigieg - Collins Stewart LLC

And then just within ESM, you mentioned, obviously, not seeing any change in the market opportunity out there. But not pursuing hiring to the same degree that you had previously to take advantage of that opportunity, could you expand on that a little bit?

Robert Beauchamp

So I may -- if I wasn't clear, we're hiring as fast as we can. There is no slowing in our efforts to hire sales people. It's just more difficult to hire sales people. There's been a lot of in the press about it, you've seen it, the Silicon Valley enterprise sales people are in demand. We are aggressively hiring to meet the demands that we see we're just behind in our hiring, and that's the issue that we're talking about when we say that we're not where we want to be on headcount.

Kevin Buttigieg - Collins Stewart LLC

And then just finally, where in terms of the guidance for the ESM business for the rest of the year, how dependent is that on large transactions?

Robert Beauchamp

Well, I mean it's in there, we have to have large transactions to certainly -- no quarter and this quarter is a good example of it. No quarter can you make without some large deals. They're in the pipeline. In fact, there's a lot of focus on large deals. A lot of the deals that we did not close in Q1. If you remember just back up a minute, if you remember Q4 a year ago was not so strong in ESM. And the reason it wasn't so strong was primarily a number of large slip deals that then we picked up and had a blowout Q1 a year ago that had the 40% growth rate that we had to compare, we had to deal with. This Q4 was very strong, and we didn't have that this year. We had the pipeline, we thought that we could get it done but we knew that the larger transactions were more back-end loaded. And then with what we saw in Federal, with what we saw in Europe, we just saw some of those larger deals slip out of our hands the last few days of the quarter. The good news is that they are very much still in play, and some are already in. And so, big deals are definitely part of our profile and will always be.

Operator

We'll go next to Walter Pritchard with Citigroup.

Robert Chen - Citigroup Inc

This is Robert for Walter. I have a question on the mainframe side. If you back out the large deal that you guys did this the quarter, do you see a change in sort of long-term growth rate in mainframe? And secondly, are you seeing share gains there on the mainframe side?

Robert Beauchamp

Well, we're doing well in mainframe, and we feel god about our competitive positioning. There's really not a lot to complain about in terms of our MSM team's doing a really good job not only in mainframe but in the control end product line as well. New customers, new add-on capacity growth, just a really good solid performance. We're not revising our long-term growth, we're still maintaining that.

Stephen Solcher

In the low to mid single-digit range. Robert, to answer your question about even if you back the deal out, we still grew that business in the quarter in the low double digit range. So that business is a lumpy business. We've always kind of indicated it's lumpy, and we had a large renewal opportunity that we took advantage of.

Robert Beauchamp

By the way, and I think it's worth noting, the large renewal opportunity was more than just a good deal, there was actually -- one of the largest mainframe customers in the world, who did business with BMC and all of our usual mainframe competitors and distributed competitors, and they came to us and said they wanted to reduce the number of vendors and really standardize on 2 vendors. And BMC, and one other company, one of the largest computer companies in the world were selected. And our other 2 core competitors were essentially eliminated, or will be eliminated from that customer. So we not only won that deal, but we also picked up footprint across the full product line as well.

Operator

We'll go now to Michael Turits with Raymond James.

Michael Turits - Raymond James & Associates, Inc.

So just 2 clarifications, 1, and I missed some of it, I apologize earlier, but ESM guidance is low on bookings, but you kept bookings and revenue for the year. Is that -- the fact that you kept things neutral, even though ESM is lower, is that simply a function of the outperformance this quarter on the mainframe and bookings side? Or why you're keeping things the same even if ESM is lower?

Robert Beauchamp

Yes, that's what it is.

Michael Turits - Raymond James & Associates, Inc.

And then, could you also just review for me the FX piece, what the change is in terms of your expectations in FX impact this quarter versus last quarter?

Stephen Solcher

So Michael, it was about a point to revenue. So we lost -- there was a natural tailwind that has become less of a tailwind. It was a point to revenue and a point to total bookings.

Michael Turits - Raymond James & Associates, Inc.

For the full year or for the quarter?

Stephen Solcher

No, that was for the full year. For the quarter, revenue was impacted by 2 points, expense by 4 points, bookings in total by 6 points, and license bookings by 8 points.

Michael Turits - Raymond James & Associates, Inc.

So for the full year, a point of tail and a point of tail. And what was it before?

Stephen Solcher

The point that I gave you in both cases is the change to our original expectation level.

Michael Turits - Raymond James & Associates, Inc.

So a point less than you originally expected?

Stephen Solcher

That's correct.

Michael Turits - Raymond James & Associates, Inc.

So there is a little bit of a de facto increase from a constant currency perspective?

Stephen Solcher

There is less of a tailwind from the impact of currency to bookings and revenue.

Operator

[Operator Instructions] We'll go back to Phil Winslow with Crédit Suisse.

Sitikantha Panigrahi - Crédit Suisse AG

This is Siti Panigrahi for Phil Winslow. So I just wanted to dig a little bit more on the mainframe side. So could you talk about what you are seeing in terms of the pricing environment? And kind of, how do you anticipate the trending as we think about the remainder of the cycle?

Robert Beauchamp

What we've done really well on pricing. In fact, once again we look at those top 15 deals. One thing we always try to watch is against the trend that you could easily fall into of trading discount to customers for going longer. And watching your annual spend go down. We saw once again our top 15 deals the average annual spend went up again. So we're able to hold our spending with the customer increase our spending with the customer, we add more footprint. There's always competition, there's always a lot of pressure between our traditional mainframe customers, but we see no increased pressure from what we've seen for some time now. We do think we're doing well though. If we look at what we see out there, what we can tell from our other competitors, we seem to be holding the line pretty well on our share.

Operator

Now moving on to Kirk Materne with Evercore Partners.

S. Kirk Materne - Evercore Partners Inc.

Bob, I was wondering, just on the mainframe side, and I apologize if you touched upon this earlier. But on their call, IBM noted since they've launched the zSeries they've added 60-some-odd customers. I guess when they're adding new mainframe customers, do you guys have a view into that? Are you participating in sort of that new customer growth, or realize it's not going to be that buoyant in the mainframe. But I was just kind of curious how those new customers buying the box or could translate into revenue for you all either at the time of the sale or down the line?

Robert Beauchamp

Yes, it does help us. Generally, the timing of any increase in capacity is related to when our contract renews. So we're always happy to see IBM ship new boxes. We're always happy to see them post, like they just did, big numbers in terms of NIP shipments, you have to discount out there the special-purpose engines and it's difficult sometimes to back into the net as you know. But in general, it looks like that their tide was rising. And that plays to our benefit. The timing plays out along the lines of our renewal dates, not at the moment of the shipments. Steve, do you have additional color on that?

Stephen Solcher

No, I would say, when we're looking at some of the transactions we're noticing about half of our capacity growth is really driven by the new box itself and the remainder is something that we expect to get over time. As Bob said, as these customers renew these contracts and we get our annual true ups.

S. Kirk Materne - Evercore Partners Inc.

And then just maybe one other for you. I guess, Bob, can you talk a little bit about how Coradiant is going to start playing with your end user experience offering? This is sort of the ATM side something you guys have always had but maybe hasn't been quite as big a focus as Blade has or Remedy has, I was just wondering what that transaction give you all, and how do you see that playing out maybe over the next 12 months?

Robert Beauchamp

Sure, our core strategy around business service management and how we deliver that through the cloud continues to be a really a powerful driver for us. Our briefing centers continue, the deals we win, the customers validate consistently our vision for how we're building out a management environment. Part of that solution is to give the customers the all-important aspect of how their customers, their end-users, perceive their responsiveness. IT for years has reported on the components. This is network availability 5 9s. This is the server response time. But really, the only measure that matters to the business on online transactions is what the eyeballs of the end-user experience, and Coradiant really brings that to us so that we can roll out a self-service, self provisioning, hybrid cloud environment to the customer, with a service level agreement tied into that. Coradiant is one of the key components that will give us the ability to then report back to the customer on how is the end-user experiencing it? Are they inside there sub-second or their 2 second, or whatever they determine it to be response times. And when something does go wrong, how quickly can we determine exactly what is the root cause. And then perhaps another BMC product like a BladeLogic, or perhaps our Remedy OnDemand trouble ticketing system will go through the logic to manage the issue. It ties the products together and it adds that part of the total value equation that is in the end-user experience, where IT really delivers its value to its customers. So it's very important to us. It's one piece, it's not the total piece, but it's an important piece of delivering on that.

Operator

[Operator Instructions] We'll go now to Matt Hedberg with RBC Capital Markets.

Matthew Hedberg - RBC Capital Markets, LLC

Clearly, there's been a lot of confusion right now in Washington right now. Can you give us an update about just sort of your feeling on the pipeline now that we're a month in to this quarter, sort of your expectations there through September?

Robert Beauchamp

Well we did -- I mean part of our guidance and part of lowering the ESM license bookings was tied to a review of our Federal business, and our belief that the Federal business has more sand in the gears than it has had in a long time. We think it's prudent for us to lower our expectations out of federal. We are closing deals with federal. I think we just got one -- closed one this week. But we clearly are lowering what we think we're going to get out of the federal government. And until we see signs of that opening back up again, we think we're going to maintain a more prudent growth expectations out of U.S. Federal.

Matthew Hedberg - RBC Capital Markets, LLC

And then in terms of the contribution side of the 2 businesses, the mainframe had a nice year-on-year pickup in terms of margin there. Can you kind of walk us through sort of your expectations there for the remainder of this year?

Stephen Solcher

So our view on margins really hasn't changed for the year from the initial guidance, and that is we're looking for of the ESM side to deliver about 100 basis points improvement in margin for the year, and then the MSM side to be almost the exact opposite, about 100 basis points of reduction, which is primarily driven from more amortization of software cap on the MSM side. So flat for the year. That's very similar to what we originally had provided.

Robert Beauchamp

Okay, we'll wrap it up now, and just one final comment. I just want to make the point that we are excited about the growth opportunities. We're excited about cloud, the growth we're seeing there. We're excited about our overachievement against our plans and our partners' plans around Software-as-a-Service.

We see the mid-teens growth rates for ESM license bookings as very achievable. We're redoubling our efforts internally to make sure we deliver consistent results across that growth. We're excited about the deals that did slip coming back into us now, this quarter. And we're looking forward to a good year ahead.

Thank you all for dialing in. We look forward to following up with any of you who would like to at future times. Thank you.

Operator

That concludes this BMC Software teleconference. Thank you, all, for joining us.

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