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BMC Software (NASDAQ:BMC)

Q2 2012 Earnings Call

October 26, 2011 5:00 pm ET

Executives

Stephen B. Solcher - Chief Financial officer and Senior Vice President

Derrick Vializ - Vice President of Investor Relations

Robert E. Beauchamp - Chairman, Chief Executive Officer and President

Analysts

James Derrick Wood - Susquehanna Financial Group, LLLP, Research Division

Gregg Moskowitz - Cowen and Company, LLC, Research Division

Philip C. Rueppel - Wells Fargo Securities, LLC, Research Division

Kevin M. Buttigieg - Collins Stewart LLC, Research Division

Michael Turits - Raymond James & Associates, Inc., Research Division

Philip Winslow - Crédit Suisse AG, Research Division

S. Kirk Materne - Evercore Partners Inc., Research Division

Aaron Schwartz - Jefferies & Company, Inc., Research Division

Walter H. Pritchard - Citigroup Inc, Research Division

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

Operator

Good day, everyone. Welcome to today's BMC Software Second 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, 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 both the second 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'd 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, 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 E. Beauchamp

Thank you, Derrick. Our second quarter performance was mixed. During the quarter, we reported solid growth in total revenue, non-GAAP operating income, non-GAAP EPS and cash flow from operations. Our MSM and professional services businesses again performed well. We did a good job of managing expenses. Both our ESM and MSM businesses maintained their technology leadership positions in their respective markets. One area of underperformance during the quarter was in ESM license bookings, which decreased 13% compared to the year-ago quarter. There were several factors driving this result that I will address shortly.

Despite our mixed performance in the second quarter, we remain confident that our strategy is sound, that our solutions are the best in the industry, that our competitive position is strong and that our long-term growth prospects are encouraging. Let me provide more specifics regarding our second quarter financial performance.

Revenue grew 11%. Non-GAAP operating income rose 13%. Non-GAAP operating margin increased by 1 percentage point. Non-GAAP diluted EPS was up 6%, and operating cash flow was up 27%. Now let me provide additional perspective on our 2 business units, beginning with ESM.

ESM license bookings were, as noted, down during the second quarter. Some of the shortfall was due to external factors. Our performance in key geographic areas and market segments, most notably certain regions in EMEA and the U.S. public sector, continued to be soft due to economic and financial conditions. We saw some deals delayed towards the end of the quarter, particularly in Europe as buying cycles elongated.

However, most of the factors driving our ESM performance were related to our own execution. While we are actively addressing these challenges, we do expect a continued negative impact in the short term and are therefore lowering our full year fiscal 2012 expectations for ESM license bookings from mid-teens growth to a mid-single digit decline.

To provide context for our second quarter performance and full year expectations, it's helpful to review the status of 2 key areas of focus heading into this year: productive sales capacity and overall sales productivity. Related to productive sales capacity, increasing our sales footprint and our ability to directly reach customers is essential to capturing the strong market demand that we see for our solutions.

However, our current expectation for productive sales capacity is significantly below our original expectation, which was for growth in the high teens for the year. We've experienced lower-than-expected hiring in the first quarter and higher-than-expected attrition in the first half. Additionally, we've seen a reduction in the overall mix of tenured sales representatives. As a result, we now expect productive sales capacity growth in the low- to mid-single digits for the year.

Related to the second key area of focus, sales productivity, in both our original fiscal 2012 expectations and our revised expectations in July, we expected an increase in overall sales productivity. However, the higher-than-expected attrition rates, particularly for the more tenured and productive sales reps, have hurt overall productivity. We've already taken several steps to respond to these challenges to increase capacity and productivity going forward.

First, we aggressively ramped hiring in the second quarter, and we'll continue that ramp through the second half of our fiscal year. Although we will take these newly hired resources sometime to be fully productive, we expect to see tangible results next year. Second, we are recruiting new senior sales leadership to fill key positions to both help to grow capacity and drive increased productivity as rapidly as possible. Finally, we're very focused on retaining existing sales talent.

As we put these steps into place to increase productive sales capacity and address overall sales productivity, it's important to note we are building on what history has shown to be a strong base and sales process, with CIO level access, leading solution suites and the industry's best training and qualification process. We have an excellent team in place. However, we need to evolve our current sales organization to increase the size of the team and make sure it has the tools required to sustain its forward momentum.

The other key areas that are important to discuss are our growth initiatives, cloud and SaaS. I'm pleased that both of these areas are performing very well for us. One of our major goals heading into the fiscal year was to establish BMC as the leader in cloud management. As customers standardize on our cloud management suite, it positions us well for long-term revenue growth.

We're executing well against this goal as indicated by our cloud results. During the quarter, the number of cloud wins and license bookings were well above plan, and we currently have a strong and growing cloud pipeline. New cloud customers include AIG, AXYS Technologies, Duke Energy, Huawei Technologies, Telstra and sanofi-aventis.

Another major strategic imperative is to become the leader in Software-as-a-Service management. The number of new SaaS customers closed in the quarter and the related amount of subscription annual contract value, ACV, continues to show strong growth. Our offerings include Remedyforce, which we offer directly and through Salesforce.com, and Remedy OnDemand, which we market directly through our BMC and reseller channel. New wins for Remedyforce include City College of New York and Hofstra University, and key wins for our Remedy OnDemand include the Spanish bank, BBVA, and City Colleges of Chicago. We are optimistic about the opportunity for these solutions.

From a financial perspective, it's important to highlight that because our SaaS business is a subscription-based offering, it is not included in our reported ESM license bookings. We were also pleased to note that during the quarter, 18 ESM customers with licensed transactions above $1 million chose to standardize across multiple BSM disciplines. One of the keys to gaining more platform wins is a relentless focus on maintaining a competitive edge for our technology in terms of its functionality and how it is seamlessly integrated.

One area of growing importance is the need for development and operations to collaborate closely to manage application changes successfully into production. This area is commonly referred to as DevOps. The recent acquisition of StreamStep, a business software provider focused on accelerating enterprise application delivery and improving release quality, positions us as a leader in this rapidly growing market segment. Our focus here is to integrate StreamStep's process management capabilities into an existing BMC solution to support seamless application management from development to production.

Another bright spot for ESM during the quarter was the performance of our professional services business. Fueled in part by increased demand for cloud implementations, our professional services revenue rose 35% for the second quarter in a row with positive gross margins.

To summarize ESM's second quarter performance, we entered fiscal 2012 with expectations that were predicated on growing productive sales capacity, improving sales productivity and winning in new markets. However, the lower-than-expected productive sales capacity and sales productivity have impacted overall ESM license bookings. We are aggressively taking actions to stem attrition and increase productivity. Our management team and entire company are focused on improving ESM's performance. In short, we have identified the issues impacting our ESM business, and we know what steps are required to increase its sales capacity and sales productivity.

We continue to benefit from the strength of our technology and see positive trends in several key areas, including cloud management, SaaS, major BSM platform wins and our professional services business. We will continue to provide you details of our progress as I do believe the market opportunities for ESM solution remain large and growing.

Let me turn now to our MSM business. MSM had another very good quarter. Total MSM bookings for the trailing 12 months increased 25% to $939 million. Total MSM annualized bookings for the trailing 12 months were up 13%. We continue to see growth in the annual spend rate of our top 15 MSM transactions in the second quarter.

During the quarter, we added or expanded our relationships with new and existing customers through 102 new product placements in MSM. We expanded our relationship with customers like TNT Express, Crédit Agricole Technologies and the Department of Treasury IT. We also saw continued strength in workload automation, which includes our BMC Control-M product line. As you know, workload automation represents about 1/3 of our MSM business. We added 13 new BMC Control-M customers and expanded our existing relationships with 55 new product placements. Some key workload automation wins in the second quarter included Continental Casualty Company, Macy's and ANZ Banking Group.

The mainframe business continues to offer very good opportunities for us. In our sixth annual worldwide mainframe survey, one of the most referenced surveys in the industry, 62% of the respondents expect to grow overall mainframe capacity. That's up from 56% last year. Among respondents at large companies, 93% expected capacity to grow or remain steady. About half of all respondents said new workloads and new business applications are contributing to their capacity growth.

Finally, it's worth noting that 60% said the top IT priority is keeping costs down. Our MSM solutions help our enterprise customers meet their key business priorities while lowering their cost of mainframe management. The need to address growing IT complexity through more efficient IT management is common to customers of both our ESM and MSM businesses. We continue to see opportunities to leverage our strengths across our distributed and mainframe IT management portfolios, among the largest enterprise customers around the world.

Let me close by summarizing why I believe we are well positioned today. While our markets are not immune from today's economic and financial uncertainties, our market opportunity is substantial and expanding. Our company is strong, focused, very profitable and committed to building shareholder value. To do so, we are intently focused on addressing our operational challenges, and we are confident that we have the correct strategy, people, products and the technology in place to capture the opportunities ahead.

Let me now turn the call over to Steve Solcher to provide a more detailed financial review of the quarter.

Stephen B. Solcher

Thank you, Bob. Before I begin, I would like to make a few brief comments regarding our financial performance. Despite the results in our ESM license bookings, I am pleased with the overall financial health of our company.

Total bookings are up 11% through the first half. Our income statement reflects strong growth in total revenue and record profitability levels. Cash flow growth is strong, and we expect fiscal 2012 to be a record year for cash flow from operations. Our balance sheet remains solid with $1.6 billion in cash and marketable securities. With those thoughts in mind, let me now turn to our financial results.

Non-GAAP operating income increased by 13% from $191 million to $216 million in the second quarter. Our second quarter non-GAAP operating margin was 39%, up 1 percentage point from the year-ago quarter. For the first half of fiscal 2012, non-GAAP operating income increased 11% from $348 million to $387 million. Non-GAAP operating margin for the first half was 37%, up 1 percentage point year-over-year.

ESM's non-GAAP operating income in the second quarter was $89 million, up 17% from the year-ago quarter. ESM's non-GAAP operating margin increased year-over-year by 1 percentage point to 26%. MSM's non-GAAP operating income in the second quarter was $127 million, up 11% from the year-ago quarter, and its non-GAAP operating margin increased 1 percentage point to 61%.

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. Our non-GAAP net earnings for the second quarter were $153 million, up 4% from the second quarter of fiscal 2011. Non-GAAP diluted EPS for the period was $0.87, which reflects a non-GAAP effective tax rate of 28% for the quarter. These non-GAAP results reflect diluted shares outstanding in the second quarter of $176 million versus $181 million in the year-ago period.

GAAP operating income in the second quarter was $161 million compared with $144 million in the year-ago quarter. GAAP net earnings and diluted earnings per share were $115 million and $0.65 per diluted share compared to $132 million and $0.73 per diluted share in the second quarter of fiscal 2011, respectively. Prior-year second quarter GAAP net earnings were positively impacted by net income tax benefits of $18 million, which were recorded in connection with tax authority settlements related to prior year's tax matters. These tax benefits were excluded from our non-GAAP results.

Turning now to bookings. Total bookings for the second quarter were $382 million, a 16% decrease compared to the year-ago quarter. On a constant currency basis, second quarter bookings decreased 14%. Total bookings for the first half were up 11% to $998 million. Total license bookings for the second quarter decreased by 15% year-over-year to $188 million. For the first half, license bookings rose 7% to $380 million. The weighted average contract length for total bookings on a trailing 12-month basis was 2.33 years, up 7% from 2.18 years in the year-ago period. After normalizing for contract length, trailing 12-month annualized bookings for the second quarter were $986 million, up 6% 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 second quarter, total ESM license bookings were $126 million, down 13% in the year-ago quarter and up 25% sequentially compared to the first quarter. For the first half of fiscal 2012, ESM license bookings were down 8% to $227 million.

Turning to the MSM business unit. Total MSM bookings for the trailing 12 months increased 25% to $939 million and had an average contract length of 3.23 years. On a constant currency basis, trailing 12-month MSM bookings were up 24%. After normalizing for contract length, MSM total annualized bookings for the trailing 12 months were up 13% as reported and 12% on a constant currency basis to $290 million.

Turning to revenue. Total revenue for the quarter was $557 million, an 11% increase compared to the second quarter of fiscal 2011. On a constant currency basis, revenue increased 10%. License revenue in the second quarter was $230 million, up 10% from a year ago. ESM license revenue was $146 million, up 11%, while MSM's license revenue was $84 million, up 9% from the second quarter of last year.

For the second quarter, maintenance revenue was $271 million, an increase of 7% compared to the year-ago quarter and up $6 million sequentially. ESM maintenance revenue was $146 million, up 7%, and MSM maintenance revenue was $125 million, up 8% compared to the second quarter of fiscal 2011. We are pleased with both the continued sequential and year-over-year growth in maintenance revenue across both of our business units.

Professional services revenue, which is included in the ESM business unit, grew 35% from the year-ago period to $57 million in the second quarter. This business delivered a non-GAAP gross margin of 8%.

Moving next to operating expenses. Non-GAAP operating expenses for the second quarter were $340 million, up 9% from the year-ago period. On a constant currency basis, non-GAAP operating expenses were up 7% year-over-year. This increase reflects the investments we are making in growth opportunities within our ESM business around cloud, SaaS and professional services as well as the impact of acquisitions.

Looking at our business units. ESM's non-GAAP operating expenses for the second quarter were $259 million, up 11% from the year-ago quarter. MSM's non-GAAP operating expenses were $81 million, up 5% compared to the year-ago quarter. We are focused on improving profitability and continue to identify opportunities to improve our cost structure across our businesses. Other income in the second quarter was a loss of $5 million compared to a slight gain in the year-ago quarter. This year-over-year decline is primarily due to a reduction in the net gains related to our deferred compensation plan.

Now turning to the balance sheet. Total deferred license revenue at the end of the second quarter was $647 million, up 8% year-over-year. During the quarter, we deferred $68 million of license revenue or 36% of license bookings and recorded $107 million of deferred license revenue from the balance sheet. The deferral rate for the quarter of 36% was impacted by a lower-than-expected deferral rate in our ESM business of 25%. Total deferred revenue decreased by $174 million sequentially to $1.9 billion. Their current portion of deferred revenue now stands at 52%.

Our net capitalized software development costs were $214 million, a 6% increase over the first quarter as we capitalized $36 million and amortized $24 million. For the year, we expect net software capitalization to be down approximately $15 million over the prior year primarily due to increased amortization. Cash and marketable securities at September 30 totaled $1.6 billion, a decrease of $126 million sequentially. Our net cash position was $1.2 billion at September 30.

For the quarter, cash flow from operations was $162 million, up 27% from the year-ago quarter. As of September 30, we have generated 51% of the midpoint of our revised full year guidance for cash flow from operations versus 38% in the previous comparable period.

During the second quarter, we repurchased 5.4 million shares of our stock for a total cost of $225 million. Our Board of Directors has authorized an additional $1 billion for share repurchases. Along with the remaining amount from prior authorizations, we now have $1.2 billion remaining in our share repurchase program.

Let me briefly sum up. We remain confident in the market opportunity ahead and in our ability to capture it. Our strategic ESM initiatives, including cloud, SaaS and professional services are exceeding our expectations. We are taking the necessary steps that we believe will reduce sales attrition and increase sales productivity, which should bode well for our continued success. Our MSM business continues to perform well. We remain a very profitable and strong company that is generating robust cash flows and is a leader in our field.

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

Robert E. Beauchamp

Thanks, Steve. Let me assure you that we have identified the issues impacting the performance of our ESM business. We know what steps are required to increase the productive capacity and overall productivity of our ESM sales organization, and we are intently engaged in that activity now, and we'll be measuring our progress and reporting it out to you regularly. With that, let me update you on our view for the remainder of fiscal 2012.

Due to our performance in the first half and our current outlook for the remainder of the year, we are lowering our full year expectations for bookings, revenue, cash flow and non-GAAP diluted earnings per share. We now expect non-GAAP diluted earnings per share in the range of $3.21 to $3.31. At the midpoint, this would represent a 9% increase over last year. This includes approximately $0.02 dilution related to the acquisition of Coradiant. This range excludes an estimated $0.88 to $0.93 per share for non-GAAP adjustments, including expenses related to the amortization of intangible assets, stock-based compensation and severance, exit costs and related charges.

The assumptions underlying our full year fiscal 2012 expectations include: total bookings growth in the mid-single digits; ESM license bookings decline in the mid-single digits; MSM total bookings growth in the high-single digits; revenue growth in the mid-single digits; operating margin staying flat with the prior year; license bookings ratable rate similar to the prior year; currency impact at today's rates, which is about a 1 point help in both bookings and revenue on a year-over-year basis; other income at a loss of approximately $10 million for the year; weighted shares outstanding approximately 4% lower than fiscal 2011; and a non-GAAP tax rate of 26% for the year. We now expect full year fiscal 2012 cash flow from operations to be between $800 million and $850 million, which at the midpoint represents an 8% improvement over fiscal 2011.

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

Question-and-Answer Session

Operator

[Operator Instructions] We'll go first to Gregg Moskowitz with Cowen.

Gregg Moskowitz - Cowen and Company, LLC, Research Division

Just to start off, we had thought that the ESM license bookings guidance would be lower. But going from mid-teens to negative mid-single digits is certainly more than I or probably anyone was expecting, and your comps do get somewhat easier in the second half. So Bob, you did talk about sales capacity and sales productivity. Just wondering if either you or Steve could talk about the other assumptions behind this guidance such as, for instance, the macro environment as well as your close rates that you're assuming.

Robert E. Beauchamp

Yes, so let me -- I'll start, Gregg. The first thing behind it is that we need to ensure that we get the sales capacity issue addressed. We just simply do not have enough feet on the street, and the ones we have don't have as much tenure as we need. And we've got to get that done before we can feel confident that we can get this thing back in the growth trajectory that we know that this market and these products will allow. So that's first. Second is, just coming off the last 2 quarters, we want to be somewhat cautious. I think that we, frankly, were disappointed with the last few days of the quarter. And when it happens 2 quarters in a row, it makes you reassess your ability to estimate what's happening out there. And as we dug into it deeper, we realize that we've got to get the sales issue under control. So we're giving out guidance that we think that we won't have to, hopefully, disappoint our shareholders again.

Gregg Moskowitz - Cowen and Company, LLC, Research Division

Okay. And then maybe this is a follow-up one I'll let others cut [ph] and go into the queue. With your license and total bookings guidance declining significantly, can you talk about cash flow? I know you're tracking well through the first half, but the full year only reflects a modest downward revision to cash flow guidance. And as you pointed out, it still reflects 8% growth at the midpoint. So maybe just talk about your confidence level in that forecast for the full year.

Stephen B. Solcher

Gregg, I'm going to take that. Cash flow for us is, as I've said in the prepared remarks, we're over halfway there to the midpoint and that relates to if you took the same timing as last year, we're probably about 40% all the way there. If you look at what really changed in the bookings number from low double to mid-single, a large portion of that are transactions that are going to occur in the fourth quarter, which will actually be cash flow in Q1. The other piece I'd like to highlight is that we have been running under our expense plan, and we expect expenses growth to moderate to kind of be in lockstep with what we're looking for top line growth. So it's really a combination of some of the bookings is really Q4, which is cash flow in Q1, and then we've done a really good job of moderating expense to kind of offset that decline in bookings.

Operator

We'll go next to Phil Winslow with Crédit Suisse.

Philip Winslow - Crédit Suisse AG, Research Division

I just want to focus back on that ESM line that -- and, Bob, you talked a lot about just the sales issues that you've had there, just with the sales force specifically. But when you actually break down ESM and think about your product line, is anyone standing out as doing better or worse, I mean, Remedy versus BladeLogic? And then is there anything going on here from a competitive standpoint, share loss, et cetera?

Robert E. Beauchamp

Okay. So let me -- first of all, on share loss, we really at this point can't find evidence that this is about losing to competition. When we look at the deals that slip or the deals that we don't close, we're not, in the vast majority, we're not chalking this up to HP or IBM or somebody took the deal away from us. So I think we just -- we need more at bats is one of our big issues. We gotten too close to where we need to close so much of the pipeline that it's just too close to the metal. We need more coverage, and more productive reps that have been here longer will provide that coverage. I think that on the product lines, cloud is doing very well. SaaS is doing very well. Both of them well ahead of plans. We can always do better, and we have plans to improve those as well, but we feel quite good about that. In terms of geographic mix, yes, there are a few standouts. U.S. federal is really behind plan, U.S. public sector in general. And we think in that market, we're coming off some tough comps, but we knew that. I think the market is just tough. U.S. public sector is just a tough market for us right now, and I think that's a macro factor. Southern Europe, it's not a big number, is pretty -- it's just not delivering much business right now. Northern Europe grew really nice, but that's an interesting one to talk about for a second. That group has continually done very well for us. They did well again. But in the last 3 days of the quarter, they had between $5 million and $10 million worth of license bookings that pushed. So we were expecting them to do well and they did, but we expect them even to do better, and we can chalk those up specifically to macro issues. But again, they did well there. In the U.S., we've got -- we had one of our regions that just has, for several quarters in a row, underperformed and that I think is self-inflicted wounds there. We've made changes in sales management there, and we just need to get that in shape. Now one of the things I'll tell you, I think we have some very good salespeople in our organization and very good methodologies, very good sales model. But this attrition issue has been with us for probably 3.5, 4 years now, and it's just not scaling. We're going to have to make a few changes to get that under control.

Operator

We'll go next to Walter Pritchard with Citi.

Walter H. Pritchard - Citigroup Inc, Research Division

Bob, just first question around attrition. I guess I didn't hear exactly what you guys are going to do to solve that. Is it a matter of paying people more? Is it a matter of structuring the organization in a way that people feel sort of set up for more success? What is this specific change that you've made there that's tangible that you think will drive lower attrition?

Robert E. Beauchamp

Sure. So a couple of things. Let me just give you one backdrop that I'll say is I think attrition is high in our industry right now in general. Now I'm going to come back and talk about us because -- but I just want to say as the backdrop. When we talk with our peers and other people in the software industry and in tech in general, it is a hot market for enterprise software sales. BMC coming off a number of very -- several strong years has been specifically -- in fact, we just interviewed a candidate from one of our ex-employees and he said that they were specifically targeting our sales force to hire. So we know that -- I just put that as the backdrop. To answer your question specifically, we've interviewed really, if not all, almost every sales representative in the company since we kind of identified that this issue was more acute than we had realized. We put in place -- we've identified what -- they told us what they see as the key issues are. One of the things we put in place is compensation plan changes to their management where attrition and recruiting are now part of the incentive system. Culturally, it has been -- or business model-wise, this sales force is a very strong sales force but culturally, it's intensely demanding. It's an organization that assumes -- that needs quarterly performance or they ask you to leave. Some of this attrition, by the way, is not people quitting. Some of it is us telling people you've been here 2 quarters or you've had 2 quarters of weak performance, you're out the door. And that model works for a smaller company. For us, we've got to have a hybrid. We've got to have some of that, but we also have to have account managers with multiyear targets and working with large accounts. And so we made changes in compensation. We're making change in management compensation. We've identified the structural issues, and in some cases, we are replacing sales management.

Walter H. Pritchard - Citigroup Inc, Research Division

And then just Steve, on the ratable mix, I noted that, and you noted it in your prepared remarks that, that was down meaningfully. Was that just a matter of lighter ESM bookings? Or what was the driver there? And remind me what you're expecting for the balance of the year.

Stephen B. Solcher

So the year-over-year change was really driven by last Q2. We had 3 or 4 really large transactions that were time-based. We knew we had a little buffer in our assumptions. For the rest of the year, we're actually looking at rates that are very similar to what we did in the last half of last year, and that's somewhere for ESM around 36%. So you're looking up from the first half, which was 27% on average, and we're looking for 36% in the latter half.

Walter H. Pritchard - Citigroup Inc, Research Division

Okay. And then just on a -- looks like finance receivables came in as a contributor to cash flow a little bit stronger than we had modeled. Is that just timing of strong ESM -- or MSM bookings you've had the last couple of quarters? Or any detail on the driver there?

Stephen B. Solcher

That's -- we don't really try to time this. This is as the balance builds up, we don't -- as you well know, we don't hold receivables. We try to sell those receivables within that 90-day period of time, and what you're seeing is off a very strong Q1. The result is, is that we're selling some of those larger finance receivables.

Operator

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

Michael Turits - Raymond James & Associates, Inc., Research Division

Thoughts on attrition. Can you drill down a little bit more into what some of the reasons for the attrition were? You said some of it was intentional due to the fact that you've had some short-term quotas, and it sounds like you're taking [ph] lengths to change that. So how much of the unanticipated attrition was unintentional and why is that happening? Maybe to ask, I don't know if it's an obvious question, but if the demand is so great, why are people leaving? Why aren't your sales guys seeing opportunity and staying and is there -- to really play this out? Is there a potential that you guys over hired with the 20% last year given the demand?

Robert E. Beauchamp

No. We didn't over hire. We under hired last year. So one thing to tell you is that since we made a big change in our sales organization and you remember when that happened, Michael, the attrition skyrocketed at that moment. And in fact, we're still down from what it was that first year after we made a lot of sales leadership changes, and that year was a serious change out in our sales organization. And that -- the business model, that sales model essentially assumed an unusually high attrition model. The concept though was that you would hire these high-quality salespeople. You would give them the opportunity to make a lot of money. You hold them accountable for consistent results, and if they didn't deliver, you would get new sales reps and you do it fairly quickly. And it was -- it worked for several years for our company, but the attrition level just kept staying high. You remember we talked about attrition on these calls for several years now. What we end up seeing is that we have -- if you look at the culture, we have a well-defined rigorous kind of value-based sales process. By the way, I think it's an outstanding process. But the culture is an aggressive performance culture and it demands consistent quarterly performance. That model is fine, I think, for a smaller company, you can afford to do that and kind of cycle through. When you're selling larger BSM offerings, when you're selling customers on your cloud solution that's going to -- that they're going to bet their future revenue models on, you have to have a little more of a hybrid model where you have account executives who are assigned to accounts. And they may not sell a lot for 3 quarters because they're working on a large standard transaction. And so the pendulum swing a little too far is what happened to us, Michael. And frankly, the sales management and the sales team here is made primarily, by the way, fantastic sales managers. But it is still the model that believes that 40% attrition is okay, and we don't believe it is okay. And the sales teams here have been working on it. There've been an awful lot of deep dive meetings here in the last month on this subject or since the end of the quarter. And I believe that everybody's got the message that we've got to get that under control. The other thing I'd tell you is that if you have a -- if you close a large interaction with BMC, you can make a lot of money. But if you're selling a BSM deal, it may take you 3 or 4 quarters to close that deal, and during that window, you may be vulnerable. If you're a hot salesperson who gets called by a startup in Silicon Valley, gets called by another competitor with a big guaranteed. We have one competitor that's offering our salespeople $250,000 guaranteed first year comp, guaranteed cash comp to go to work for them. And so there's just lots of opportunities, and it's a tough culture and we've got to address that through changing kind of the way we think about attrition and develop these sales people. And they have plenty of opportunity to make a lot of money. We have a lot of salespeople who make a lot of money here, Michael.

Michael Turits - Raymond James & Associates, Inc., Research Division

If I could just follow up in a different direction, just on the other portions of ESM besides cloud and SaaS, so what's called Remedy -- Remedy and Blade, at least those 2 portions. So I just want to make sure those things are doing well. You said you don't think you're losing competitively. Is demand slipping specifically on the Remedy side? Or in fact, is that getting more mature? And are you sure you're not seeing perhaps some losses competitively to SaaS-based companies like ServiceNow?

Robert E. Beauchamp

Well, we certainly do have competitors like the one you just mentioned. But I think that in general, I mean, Remedy ITSM has the highest maintenance renewal rates in our portfolio, so we're having very, very low cancellation rates. We are competing and winning SaaS. I mean, if you remember it wasn’t too many quarters ago, we didn't have a SaaS offering at all. So if the customer made the decision to go to SaaS, we lost all those deals 18 months ago. Today, we're winning a lot of them and in fact, just did a major replacement of ServiceNow, one of their largest accounts, after they've been in there for a couple of years. But we went in and just did a complete replacement. In fact, the customer standardized on our whole cloud solution, standardized on our automation, BladeLogic, and all of the automation products on top of it, our monitoring solution. Professional services was in the deal. It was a complete standardization. By the way, this was a customer that had very little business with BMC. It's a Fortune 500 New York-based financial services company, just standardized on us and replaced them. So we are -- yes, there are deals out there that we certainly -- we compete and we lose on some. But it's not a big number that we can track. What worries me is the deals we don't know about. And because when we know about it, we do pretty well. But we don't know about enough deals. We've got to get the pipeline built and got to get more people building it.

Operator

And Aaron Schwartz with Jefferies has our next question.

Aaron Schwartz - Jefferies & Company, Inc., Research Division

I know you've talked a lot about the issues within BSM in terms of attrition, et cetera. But you've also talked a lot about the cloud and some of the other new growth areas. Why would that not over the longer term create a higher deferral rate and I guess slow license growth in the meantime? I mean, is that something we should think about longer term beyond just kind of these near-term operational issues?

Stephen B. Solcher

I wouldn't say that cloud would do it. But as we do more SaaS because that is a subscription-based business, it will have a natural headwind to the income statement. And typically, a SaaS transaction is going to be smaller than the aggregate of a perpetual plus the first year maintenance.

Robert E. Beauchamp

When we sell cloud, like our cloud life cycle manager, that's very often. That's an upfront model. It is giving them the software they need to run their cloud, and that's an upfront model just like we sell traditionally. The SaaS though, as Steve mentioned, is clearly a different model.

Aaron Schwartz - Jefferies & Company, Inc., Research Division

Okay. And then within some of the attrition issues that you talked to, I mean, you sort of were very upfront, clear that you've identified these issues and can get an immediate fix around that. I mean, was this something that you sort of identified, I guess, after the quarter closed? Or it sounds like the attrition has always been there. But has it just been the results the last couple of quarters that have sort of elevated it in terms of the priorities? Or can you just walk us through, sort of, the timeline there?

Robert E. Beauchamp

Yes. What you said is correct. What happened is that we've identified -- in fact, we've been tracking it. We report out in our internal meetings on attrition and have been doing it for some time knowing it needed to improve. But then after -- with Q1 and then followed with Q2 we said, "Hang on. We got to get to the root cause of what's going on with this. How did we go from being able to forecast for several years in a row with pretty solid accuracy and the same sales management generally in place doing it to having this kind of performance?" And so we went through a really deep dive on the attrition level. And what we saw, for instance, in Q2 was a jump in tenured sales reps, those who have been here 3 years, for instance, and beyond. We're able to hire well. We're bringing in some bright young talent, new talent. But when you lose the people that are more tenured, then you lose a lot of that sophistication and forecasting and more productive salespeople. So what's happened as a result of this when we -- after Q2's performance is we really went very, very deep into analyzing what's going on with that attrition level. Because we had the pipeline, we had the forecast. The numbers that we trusted for several years were in place and in fact, had been scrubbed pretty nicely after Q1 and yet they disappointed us. And so we went in quite a bit deeper, and we collectively in the sales -- the sales leadership would tell you -- in fact, I'd tell you specifically that if we were at capacity, we would have delivered the plan, we would delivered the numbers that you'd expected in both Q1 and Q2.

Aaron Schwartz - Jefferies & Company, Inc., Research Division

And I guess a follow-up question there is, when you get to capacity or as you're in the process of getting there, I mean, how long does that take to rebuild the pipeline? I mean, it seems like that's going to be a multi-quarter rebuild.

Robert E. Beauchamp

Yes. It is and that's part of the numbers that we gave you for the rest of the year. We think we'll be able to make immediate improvement on the total headcount, total capacity. We hired -- we did very well in hiring in Q2. We've got the hiring engines on high. These attrition initiatives we talked about, with sales compensation, with things that we're doing to try to make the salespeople more productive so they can make more money. We've adjusted some of their compensation plans, as well, to help them, so that they can feel more comfortable with gaps and things like that in their sales forecast so that they can -- it's not quite as a high risk of a place to work for them. We've made those changes. We expect to see attrition moderate soon, and then it just takes some time. If -- we generally think of 2 to 3 quarters for a salesperson to be more productive, and we know that a salesperson on the second year will be materially more productive than the first year and the third year, they'll be more productive than their second. So it will -- to get to full capacity to what we think is necessary, there's a little bit of a lag here, but we're going to be full speed on it.

Aaron Schwartz - Jefferies & Company, Inc., Research Division

Okay. And last question if I could, but on the additional buyback, is that discretionary? Or is that a 10b5-1?

Stephen B. Solcher

It is -- well, what we do is every quarter, it's really both programs. We do have a 10b5 that we do 90 days in advance. And then we, on top of that, do an open market. But we only do that every 90 days, so we're not locked into any type of buying pattern on the 10b5-1.

Operator

We'll move on to Philip Rueppel with Wells Fargo Securities.

Philip C. Rueppel - Wells Fargo Securities, LLC, Research Division

Just sort of focusing, you've addressed the attrition very well. But on the productivity side, as you look forward, it sounds like you both identified the fact that the pipeline isn't big enough and you weren't able to close or the close rates were less than you'd expected. As you look into your new forecast for the second half, are you kind of -- are you assuming any improvement in close rates? And is there a great assumption that the pipeline will build? Or are you kind of looking at where you are today and extrapolating forward?

Stephen B. Solcher

We're going to look -- I'll give you both views of it. So the close rate we're expecting to be better than the first half, and that was well below our historical average. But if you look year-over-year on the second half, we expect our close rate to be slightly down than what we had closed in the last -- latter half of last year. And then of course pipe, we're trying to build pipe as fast as possible, and we have a gross pipe that's building really nice. And then what we really look at is a weighted pipe and that's weighting by stage, and we're trying to scrub it, as Bob said earlier, in every single way that we can to ensure that we have enough coverage.

Philip C. Rueppel - Wells Fargo Securities, LLC, Research Division

Right. And the commentary about some of the bookings decline would be more pronounced in the fourth quarter, is there any worry that there isn't going to be a typical budget flush either in your third quarter or sort of year end in your fourth quarter sort of strength from a macro perspective? Or is it really just having scrubbed the pipe as it stands?

Robert E. Beauchamp

We don't -- we're not baking in a budget flush bonus on top of the rolled up forecast. We're taking the forecast at face value to begin with and then discounting that, not the other way around basically.

Stephen B. Solcher

I mean, the math would say we're up in the first half 11%, and we just got into the mid-single digit range. I mean, you can interpret the math that we're going to be flat in the second half. So we are trying to be pretty conservative in our view of where growth is coming from.

Operator

Moving next to Matt Hedberg with RBC Capital Markets.

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

I think, Bob, you might have mentioned that the public sector was weak and certainly, Europe has their issues. Can you talk about some other verticals, financial services, telco? I mean, how are some of the other verticals doing?

Robert E. Beauchamp

I don't know that I have too much insight there beyond the traditional patterns we've seen. I think financial services is certainly under more pressure, but we did some really nice deals there. I mean, some of our -- the large transaction I mentioned where we replaced our SaaS competitor and IT service management and where they standardized on our cloud is a giant multinational financial services company. And then one of the other large deals, if not the biggest deal, I think it was, wasn't it Steve, of the quarter was also another multinational bank and -- headquartered here in the United States that standardized on. So we're getting deals with large banks. They've got to cut costs. They've got to modernize their IT, and they're picking us to do so. Telco, I would say in general, we had some nice telco wins that were cloud-related. But the cloud deals are usually smaller ASPs where they do a proof of concept or they stand up a store front, and it's kind of the build it and they will come sort of model for cloud. And they usually buy enough from us to stand the cloud up. And then our contracts are structured so that as they build cloud volume, we have the upside to do more business with them. So I don't have the numbers in front of me so I shouldn't speculate. But my gut tells me that financial services did well with those 2 of our largest deals, and telco's probably a little under what it normally would be.

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

And then you also mentioned professional services was up pretty good this quarter and that's for the past couple of quarters. Do you guys look at that as a positive indicator for future proof of concepts or deals? How do you kind of get your arms around professional services?

Robert E. Beauchamp

It's positive in a lot of ways. I tell you one of the reasons it's positive is back to the sales force issue. One of the most important things that the sales force needs to do to be productive, and this is an issue when you're under capacity that can bite you, is that if you're a salesperson and you close a large, say, a $10 million deal with a customer with a lot of BMC products, you're going to be occupied with that customer on implementation. As we get better and better and grow in our services organization so that we're not capacity constrained on services, the services our project managers are able to take control of that implementation and successfully implement it rapidly, which brings the customer -- gives the customer the good feeling to come back and do more and more with you. Earlier in our evolution when our services were struggling more, it consumes more sales time. It still does consume some sales time, but particularly under capacity. But that is a real positive indicator. And also, a lot of the sales -- a lot of the services growth was cloud-related, and we've got that down to a much more cookie cutter profitable sort of business for ourselves now and that success breeds success.

Operator

We'll now hear from Kevin Buttigieg with Collins Stewart.

Kevin M. Buttigieg - Collins Stewart LLC, Research Division

Obviously, you talked a lot about attrition. One thing that you've alluded to was the turnover in sales management in the ESM business. I was wondering if you could go into a little bit more detail around that, particularly around turnover in the senior sales leadership positions within the ESM business. Obviously, that has been a concern among investors within recent weeks. So I'm just wondering if you could clear that up now.

Robert E. Beauchamp

Yes, sure. One, so specifically at the very top, John McMahon came into the BladeLogic implementation and put what I think is one of the best sales organizations I've ever seen in place and put some wonderful -- and then after him Luca Lazzaron, continued to develop that. So I give him a lot of credit for building -- for really helping transform our company by building a great, aggressive hunter sales force. John really stepped out of the picture. His first big step out of the picture was February 2010 whenever he went to his 2 direct reports, and Luca took over worldwide sales as Senior Vice President of worldwide sales in 2010. And Luca then began kind of attending my staff meetings and was part of the senior team as he really ran sales himself. John stepped out of the company further in February of this year when he actually had no -- he just became an individual contributor and kind of consulting and mentoring and coaching, but had no line responsibilities whatsoever. At that point, he was reporting to one of my direct reports. Luca at that point was driving the sales organization. So on October 1, as soon as we finished Q2 and Luca worked very, very hard and diligently through the whole quarter, Luca and I both agreed that it was probably a good time for change. And so he has moved on and we owe him a great debt of gratitude for helping build us out a great sale organization. So those are the top 2 people you referred to. And then beneath that, we had some execution issues in a couple of areas of sales. One is the forecast that dropped the farthest, the fastest in the last few days and that was U.S. West and that individual is no longer with the company, and we will be announcing a replacement for him very shortly. We're also interviewing and we have offers outstanding right now for some fairly senior salespeople are sales management in things like sales operations and others for companies who are perhaps a step ahead of us in maturity, so that we can evolve from not just a hunter model but a little bit of the hunter and strategic account management model that we're going to need in order to kind of take our game to the next level.

Kevin M. Buttigieg - Collins Stewart LLC, Research Division

Okay. And then is there a plan to replace Luca, or is Paul going to be running sales?

Robert E. Beauchamp

For right now, Paul's got the GO head reporting directly to him, the 3 GO heads reporting directly to him and indirect. And as soon as -- we will announce something around that shortly, but we're not prepared to announce it today.

Operator

And Derrick Wood with Susquehanna has our next question.

James Derrick Wood - Susquehanna Financial Group, LLLP, Research Division

So it sounds like in terms of the sales structure, you plan to make 2 changes. One is going to be around compensation structure, and the other is going to be around this hybrid model. For the latter, with people acting as account executives and not revenue producing, you think this changes the profitability levels that we should think about this business? And perhaps, you may have to give up margins for a little bit more stability in your sales force?

Robert E. Beauchamp

Well, so two things there. One is account executives have big hairy quarters. They are revenue generators, but they are not necessarily quarterly driven. Our culture has, and I give an example, we had a salesperson a couple of years ago who had 2 weak quarters and was in the process of being put on a plan to be let go and which -- who was a proven salesperson. I intervened in that particular one. That individual closed one of the largest deals we've closed in the last 3 years a quarter or 2 later. Some of these deals just take a while to build out. But I would also tell you, attrition is unbelievably expensive. So if we can get this attrition down, I think it will more than pay for itself and it will not be dilutive to profitability. If anything, it will be accretive to profitability.

James Derrick Wood - Susquehanna Financial Group, LLLP, Research Division

And so then I mean, can you clarify what the change to a hybrid model would entail?

Robert E. Beauchamp

Sure. Yes, basically, what you're looking at is a sales -- rather than a one-size-fits-all, all salespeople basically have the same quota, everybody gets measured on 90-day increments, you have some people who are clearly measured that way. Not saying everybody, I'm exaggerating a little bit. We're not that uniformed completely across the company, but largely that's the model. Over time, that would evolve or what we would like to evolve that to is having account executives who have larger quotas, maybe only 1 or 2 accounts but they have very big numbers and they develop those relationships and build those relationships over a number of years. They may even -- they may sell both mainframe and distributed. That's a decision that we're looking at. Again, this would only be the large global accounts, but we need that sort of global account. If you're selling to the largest banks in Manhattan, you need to have some consistency on the account team, and our turnover on some of those banks has just been unacceptably high.

James Derrick Wood - Susquehanna Financial Group, LLLP, Research Division

All right. Last question, just on the Coradiant business and the integration of that company and that product set. How is that tracked relative to plan? Is that kind of seeing the same sort of execution, the struggles? Or if you could comment on that, that would be great.

Stephen B. Solcher

It's actually doing better than the overall results, but it is slightly behind plan. The integration is on track. So I'd say the vast majority of the challenges of integrating product as well as the selling notion is kind of behind us. But we're slightly under where we would like to be today, but it's nothing like the rest of the business.

Operator

And our final question will come from Kirk Materne with Evercore Partners.

S. Kirk Materne - Evercore Partners Inc., Research Division

I guess my question would be there's a lot more companies out there talking about helping big organizations deal with virtualization management and cloud management. And I guess, do you think any of the shortfall or any of the, I guess, -- is due to just your message may be just getting lost in the mix with everybody else? And there's a lot of people that say they can do a lot of things but can't actually execute against it? And I assume that having this amount of attrition just sort of amplifies that issue. But can you just talk about...

Stephen B. Solcher

Sure. We're...

Robert E. Beauchamp

Sure. I'll tell you why I don't think that because our cloud business is doing very well, our win rates. I just got an e-mail today that was forwarded to me by a customer who sent it to our sales team saying that our cloud proof of concept that we put in for a couple of months just blew him away, said it just absolutely blew him away. It was an architecture based on B block architecture with Cisco and using BMC's cloud life cycle manager, and the e-mail from the customer was effusive, talking about how it blew him away. So the cloud business is doing excellent. I would say that what maybe -- it's not exactly what you asked, but what definitely can happen to us being under capacity is our salespeople are selling what is easy to sell or what is easier to sell, which is cloud, which is SaaS. And they're diverting to where the customers are saying, "I'm going to buy now in this area. Come to the -- let's engage in a contract negotiation. Let's engage in an evaluation." What would suffer if you're under capacity is that now, you're not necessarily out there driving a Remedy ITSM upgrade or a -- to helping a customer add the new knowledge management or change management modules on top of it or taking BladeLogic up to do applications provisioning and middleware provisioning. So while those businesses are still a big part of our business, I think it's the opposite. I think we're doing very well in cloud, and I think that the attention it's getting from our sales force is strong. And some of the stuff that we're really focused on 2 years ago is maybe taking a little bit of a backseat as we -- as our laissez-faire sales model basically focuses on what the customers want now.

All right. Well, listen. I want to thank you very much. Appreciate you dialing in. I think we, hopefully, made it very clear to you that we think we've got some outstanding products. We think we're in some excellent markets. And frankly, we need to get this sales force grown, matured. We've got the best salespeople and some of the best sales management in the industry, but our company has grown past the point of a single model. We're going to be highly focused on this, and we will be reporting to you in our progress, so that you can draw your own conclusions as to our ability to get back to the growth trajectory that we know that our company and this market will give us.

Thank you all very much.

Operator

That concludes today's conference. Thank you all for joining us.

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