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BMC Software, Inc. (NASDAQ:BMC)

F1Q08 Earnings Call

August 6, 2007 5:00 pm ET

Executives

Derrick Vializ - Investor Relations

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

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

Analysts

Philip Winslow - Credit Suisse

Walter Pritchard - Cowen & Company

Kevin Buttigieg - AG Edwards

Derek Bingham - Goldman Sachs

Israel Hernandez - Lehman Brothers

Brendan McCabe - CIBC World Markets

Tom Curlin - RBC Capital

Jeffrey Constantino - Banc of America

Tim Klasell - Thomas Weisel

Richard Sherman - MKM Partners

Presentation

Operator

Good day, everyone. Welcome to today’s BMC Software first quarter earnings results conference call. Just a reminder, today’s conference is being recorded. And now at this time for opening remarks and introductions, I would like to turn the conference over to Mr. Derrick Vializ. Please go ahead, sir.

Derrick Vializ

Good afternoon, everyone. I’m Derrick Vializ, Vice President of Investor Relations. Today’s call is being webcast and is also being recorded. An archive of the recording will be available this evening on our website. In addition to today’s earnings press release, we have posted a presentation which we will refer to at various times during the call. Both of these documents are available on our investor relations website at bmc.com/investors.

During our call, Bob Beauchamp, our CEO, will provide an overview of our first quarter performance, an update on our business service management strategy, and an update on our mainframes business. After that, Stephen Solcher, our CFO, will provide additional financial and operational details. Bob will then update our guidance for fiscal 2008 before we open the call to questions.

Before we continue, I would like to remind you that statements in this discussion, including statements made during the question-and-answer session regarding BMC's future financial and operating results, the development of and demand for BMC's products, BMC's operating strategies, acquisitions, and other statements that are not statements 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 the financial presentation, and in our annual report on Form 10-K.

All of these documents are available on our website. These forward-looking statements are made as of today based on certain expectations and we undertake no duty to update these forward-looking statements.

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

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

Robert E. Beauchamp

Thanks, Derrick. Good afternoon and thank you for joining our call. As you know, we concluded fiscal 2007 with a strong fourth quarter. Today I am pleased to report that we carried this momentum into fiscal 2008 with yet again another strong quarter that gets the year off to an excellent start.

We continue to extend our leadership in business service management and to drive strong top line and bottom line performance. We exceeded our non-GAAP EPS and revenue guidance while significantly increasing our cash flow from operations over the year-ago period. These improved fundamentals, coupled with our newly authorized $1 billion share repurchase program, position us well to further increase shareholder value.

I would like to highlight several key metrics for the quarter. First, bookings -- bookings grew 19% in the first quarter on a year-over-year basis. This follows bookings growth of 22% in the fourth quarter. BMC's first quarter bookings growth was broad-based, with increases across both the enterprise service management and mainframe service management business units.

We also had growth in both license and maintenance bookings. In fact, license bookings increased 55%, the highest percentage increase that we have generated in the past 10 years.

From the strong bookings performance in the fiscal 2007 fourth quarter, BMC generated $165 million in cash flow from operations in the fiscal 2008 first quarter. I want to add that with the strong level of bookings we achieved in the first quarter, we expect that cash flow generation will remain very healthy in the second quarter.

Revenues in the quarter increased 7% to $385 million. This is $5 million above the high-end of our guidance which, as a reminder, was $365 million to $380 million. We achieved this growth rate even with a very high ratable rate in the first quarter. In addition, revenues rose in all our major regions on a year-over-year basis, with the U.S. being particularly strong.

In terms of revenues by business segment, total revenues for ESM and MSM increased 6% and 7% respectively in the first quarter. Our non-GAAP operating margin was 23% for the quarter, up from 19% in the year-ago period. This improvement reflects the operating leverage we enjoy in our business model. Virtually all of the additional revenue we generated this quarter fell to the non-GAAP operating income line.

We also exceeded our non-GAAP earnings per share guidance. This was the ninth consecutive quarter that we have met or exceeded our revenue and non-GAAP EPS guidance. Non-GAAP diluted EPS for the period was $0.37, up 19% compared to the year-ago period.

So that gives you a snapshot of our performance. Total bookings, license bookings, cash flow, revenues, operating margin, operating income and earnings per share -- all of these metrics show very positive results and trends and they also clearly show that we have successfully transformed BMC in our drive to build value for shareholders. We like the progress we are making and we believe there is plenty more to achieve. That’s our focus as we move through the balance of fiscal 2008.

Business service management remains a key driver for our improved performance, both today and tomorrow. As you know from both the industry press and industry analysts, we are the leader in business service management. During the quarter, we completed a number of strategic wins with key customers for our BSM solutions, such as the U.S. Army, PG&E, and a number of civilian government agencies, such as the EPA, the FAA, Postal Service, and Department of Veteran Affairs. We are continuing to invest in technology and people so that we can maintain and increase our lead in BSM, which we view as a high-growth market.

During the first quarter, we closed the acquisition of ProactiveNet. We are continuing to sell ProactiveNet offerings on a standalone basis but we are well along in integrating the early warning system for IT into our comprehensive BSM solutions.

Forrester Research noted in a recent report that “the acquisition gives BMC a significant advantage over competitors. The combined BMC ProactiveNet solution will enable customers to extend their business service management capabilities with BMC's CMDB enabled solutions, as well as extend their service level agreements to other areas, such as change and configuration management”.

In early July, we announced another transaction -- the acquisition of RealOps, the leader in run book automation solutions. As I’ve said before, the next big step forward for BSM lies in advancing IT process automation. In particular, RealOps run book automation solution, coupled with our Atrium CMDB, will enable IT organizations to integrate and automate operational activities across the range of IT management functions. It will give our customers an unprecedented level of intelligent automation that enables them to improve productivity and service levels while reducing costs. Our BMC remedy IT process automation platform positions us well in this area, and RealOps will complement and extend our capabilities.

The acquisitions of ProactiveNet and RealOps share some common features. From a strategic standpoint, they extend our BSM strategy, both in terms of our BSM vision as well as the BSM solution set that we can deliver to the market today.

We are well ahead of our competitors and these acquisitions further enhance our strategic positioning and competitive advantage.

From an operational standpoint, there’s a clear integration path. Bringing them under the BMC umbrella will be a smooth process. Our solutions are being jointly used by multiple customers. This minimizes risk and helps to optimize our ability to quickly come together and add value for customers.

In the case of RealOps, we had a strong market relationship and we often pull them into deals to enhance our competitive positioning. In these situations, the combination of RealOps and BMC delivered well-orchestrated data center automation. With the integration across a broad set of management solutions, we enhance process visibility for IT and the business.

From a financial standpoint, these precision purchases of technology have minimal short-term impact but will have a profound impact over the mid-term. As we move forward, we have a clear roadmap for the future of our business, which will continue to include acquisitions.

Let me move on to discuss our MSM business. We are encouraged by the overall trends driving the mainframe industry, as well as by the performance of our business. According to a July 2007 report from industry analyst IDC, BMC ranked first in terms of market share in mainframe database development and management tools. In fact, IDC says that BMC dominates the market.

This report indicates that our strategy in the large, healthy and mature mainframe market is clearly working. We are winning market share and we are leveraging our leadership position and highly focused dedication organization while integrating our mainframe offerings with our BSM architecture.

During the first quarter, we signed important MSM contracts with a number of companies, including EDS Depository Trust Company, Fortis, and Banco Bradesco. These wins either extend our relationship with current customers or displaced our competition.

To summarize, our business performed very, very well this quarter. We had another strong quarter in terms of total bookings, license bookings, cash flow, revenues, operating margins, operating income, and earnings per share. We are executing well in terms of both our BSM strategy and our MSM strategy. We are continuing to generate growth in our core BSM business and we are also winning market share in our MSM business. We are improving our productivity and operating efficiency, as reflected in the strong operating leverage we demonstrated during the quarter.

In short, we’ve come a long way in each of these areas and our first quarter results add to our track record of success. We aim to extend that record throughout the 2008 fiscal year. I’ll come back to you later to update you on our improved guidance for the year, but before I do that let me turn the call over to Stephen Solcher for a more detailed operational and financial review. Stephen.

Stephen B. Solcher

Thanks, Bob. It’s clear that we had another excellent quarter. I am especially pleased with the continued consistency of our execution and our results, as this is the ninth quarter in a row where BMC has met or exceeded our revenue and non-GAAP EPS guidance.

One of the more encouraging results in the quarter was cash flow from operations, which tripled last year’s performance. Solid first quarter bookings position us well for another quarter of strong cash flow growth.

As Bob mentioned, our first quarter financial performance demonstrates the power of our operating leverage, driven from both increased revenues and our continued success at cost control. In fact, non-GAAP operating expenses have remained largely flat now for two years running, even as we absorbed increases in our expense run-rate from acquisitions and the negative impact from currency movements.

With that, let me start off by reviewing our financial results. In the first quarter, non-GAAP operating income increased by 31% from $68 million to $89 million. Non-GAAP operating margin increased from 19% in the year-ago quarter to 23% this quarter, the highest first quarter non-GAAP operating margin since 2000. We expect continued year-over-year improvement in our non-GAAP operating margin throughout fiscal 2008.

Non-GAAP net earnings for the first quarter were $77 million, an increase of 17% over fiscal 2007. Non-GAAP diluted EPS for the period was $0.37, up 19% compared to the year-ago period. This reflects a non-GAAP effective tax rate for the quarter of 30% compared to 27% in the first quarter of fiscal 2007. These non-GAAP results reflect diluted shares outstanding in the first quarter of 205 million versus 211 million in the year-ago period.

GAAP operating income in the first quarter was $61 million compared to $19 million in the year-ago period. GAAP net income and fully diluted EPS were $57 million and $0.28, compared to $31 million and $0.15 in the first quarter of fiscal 2007.

Turning now to bookings, as Bob noted, we saw continued strength in bookings in each of our business units. Total bookings of $438 million were up 19% compared to the year-ago period. Particular strength in the first quarter came from license bookings, which rose 55% compared to the first quarter of fiscal 2007. This strong license bookings growth was primarily driven from our MSM business and our distributed systems management solutions.

Total bookings on a trailing 12-month basis were $1.75 billion, up 17% compared to the year-ago period. The weighted average contract length for total bookings on a trailing 12-month basis was 2.4 years compared to 2.2 years in the year-ago period.

With the increase in bookings, and after normalizing for contract length, trailing 12-month annualized bookings for the first quarter of fiscal 2008 increased 6% over the year-ago period to $733 million. This is now the sixth consecutive quarter in which we’ve achieved annualized bookings growth on a trailing 12-month basis. Please refer to slide 7 in our presentation.

Now let me turn to the performance of each of our business units. For our ESM business unit, license bookings are the best measure of performance. Total ESM license bookings were $70 million in the first quarter, up 30% from the year-ago period. Within our ESM business unit, license bookings of our core BSM product group were up 10% in the first quarter. This marks the sixth consecutive quarter of double-digit growth in core BSM license bookings. See slide 8 of our presentation of historical license bookings growth.

During the quarter, we saw significant growth in license bookings of our distributed systems management solutions. DSM license bookings nearly doubled to $25 million in the quarter.

Turning to our mainframe unit, we believe the MSM business unit is best evaluated on the basis of total and annualized bookings over the trailing 12 months. In the first quarter, total MSM bookings on a trailing 12-month basis increased 16% to $747 million, with an average contract length of 3.1 years. In the year-ago period, total MSM bookings were $643 million with an average contract length of 2.9 years. Total annualized MSM bookings for the trailing 12 months were up 7% to $239 million.

As Bob noted earlier, we are pleased with the bookings performance of this business in the quarter. However, this is still a lumpy business in which bookings can vary from quarter to quarter. Our long-term expectations for this business have not changed.

Turning to revenues, total revenues for the quarter were $385 million, a 7% increase compared to the first quarter of fiscal 2007. License revenues in the first quarter were $126 million, an increase of 13% compared to a year ago. During the quarter, the percentage of license bookings that was deferred was 58%, which represents a historical high and was considerably higher than the 39% in the year-ago period.

One of the key drivers for the increase in the ratable rate was that MSM license bookings comprised a relatively high percentage of total license bookings this quarter as compared to prior periods. Obviously, the higher ratable rate affects the amount of revenue we recognize in the current period. At the same time, it increases deferred license revenue and adds visibility into our revenue stream going forward.

We had license revenue increases in all major geographic regions during the quarter, including exceptionally strong license revenue performance in the U.S., our strongest market.

Maintenance revenues in the first quarter of 2008 were $236 million, up $6 million sequentially and up 3% compared to a year ago.

Professional services revenues were $24 million in the first quarter, up 10% compared to $21 million in the year-ago period.

Moving next to operating expenses, we had another good quarter of controlling our expenses. Non-GAAP operating expenses were $296 million, essentially flat with the year-ago period. This is the ninth consecutive quarter in which non-GAAP operating expenses had decreased or remained flat on a year-over-year basis.

As I mentioned earlier, this positive trend has been achieved despite absorbing expenses from acquisitions, internal investments, and the negative impact of currency movements.

We are targeting further improvement in our cost structure as we drive to simplify and standardize our business processes. This is an ongoing effort that is broad-based across the company and we expect incremental savings to flow through over time.

Now, turning to the balance sheet, total deferred license revenue at the end of the first quarter was $520 million, a record level and an increase of $16 million on a sequential basis. During the quarter, we deferred $83 million of license revenues, or 58% of license bookings, and recognized $67 million of deferred license revenues from the balance sheet. Total deferred revenue increased by $53 million sequentially to $1.78 billion, a record high level.

We had particular strength in short-term deferred revenues, which increased $33 million sequentially. Software development costs on the balance sheet were $107 million, $3 million more than at the end of the fourth quarter of 2007, as we capitalized $19 million and amortized $16 million during the quarter. Cash and marketable securities at June 30th were also at a record level, totaling $1.57 billion.

For the quarter, cash flow from operations was $165 million, an increase of 200% over the prior year. During the first quarter, we repurchased 2.6 million shares for an aggregate value of $83 million.

Recently, we announced that our Board of Directors approved the authorization to repurchase up to $1 billion worth of our company’s shares. We now have $1.2 billion remaining in our stock repurchase program. With this increased share repurchase program, we are moving forward aggressively with our share buy-back activity.

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

Robert E. Beauchamp

Thank you, Stephen. As I mentioned, I am pleased with our first quarter performance. We improved on all our key performance metrics -- bookings, revenues, earnings and cash flow, and we are succeeding in three key strategic areas of focus that we have set for our company. We are generating top line growth in business service management. We are maintaining the profitability and cash flow of our mainframe service management business and we are becoming a leaner, more agile and more productive enterprise.

Let me now update you on our guidance for fiscal 2008. We now expect non-GAAP EPS for the year to be in the range of $1.69 to $1.79 per share. Non-GAAP EPS excludes an estimated $0.36 of special items related to expenses for amortization of acquired technology and intangibles, in-process research and development, share-based compensation, and restructuring activity.

The assumptions underlying this full year fiscal 2008 estimate include: we now expect revenue growth in the mid-single-digits. This is at the high-end of the range we originally discussed last quarter; total bookings growth in the low single digits; a license bookings ratable rate similar to last year; non-GAAP operating expenses that are essentially flat; and a non-GAAP effective tax rate of 30%.

As a result of our strong first quarter performance, we are increasing our expectations for cash flow from operations. We now expect cash flow from operations to improve to between $500 million and $550 million, including an estimated $25 million in cash restructuring payments.

So as you can see, we are targeting another year of solid performance in terms of all the key financial metrics.

Turning to our guidance for the second fiscal quarter, we anticipate second quarter revenues to range between $395 million and $410 million, and non-GAAP EPS to be in the range of $0.39 to $0.44. This reflects a non-GAAP effective tax rate of 30%.

Non-GAAP EPS excludes an estimated $0.09 of special items related to expenses for amortization of acquired technology and intangibles, in-process research and development, share-based compensation and restructuring activity.

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

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go first today to Mr. Philip Winslow at Credit Suisse.

Philip Winslow - Credit Suisse

Hi, guys. Good quarter. I wonder if you all could just comment on just the pricing environment in the mainframe sector. Obviously you’ve had very strong license bookings over the past multiple quarters there. I’m just wondering if you could comment just pricing but also just competitively what you are seeing.

Robert E. Beauchamp

Well, we had some very nice competitive wins this quarter, including some competitive replacements. We did not see -- we did not see any atrophy in pricing. In fact, I’d say that we have seen more stability in pricing in the last few quarters than in years gone by. I think that is partially due to the fact that the IBM MIPS shipments, particularly in accounts that are above 10,000 MIPS appear to be growing well and also due to more discipline in the sales process as we have a dedicated organization focused on mainframe that is doing a solid job of selling value.

Philip Winslow - Credit Suisse

Great, thanks.

Operator

We’ll go next now to Mr. Walter Pritchard at Cowen & Company.

Walter Pritchard - Cowen & Company

Just wondering if you could talk a little bit about the bookings, the way you got to the bookings growth. It seemed -- I didn’t expect mainframe and distributor to grow 90% or so and it looks like BSM grew about 10%, sort of the opposite directionally I was expecting. Could you just walk us through the strength on one and the weakness, or apparent weakness in the other and if you think that is going to be sustained?

Robert E. Beauchamp

Sure. I’ll do it in reverse order. If you think back last year, we saw the same BSM growth, about 10%, 11% last year, so on a seasonal basis, this is about what you would expect and we expect that to improve every quarter for the rest of the year. We had no large transactions in our BSM business because you came off the strong Q4, where the whales tend to congregate on new business. So that was in line basically with where we expected it to be and we expect it to strengthen throughout the year.

As it relates to DSM and MSM, those are -- that business grew up in the ear of large transactions and therefore both of those parts of our business are lumpy, and we had a strong quarter with some large transactions. We do not expect DSM to grow at those kinds of rates. Long-term, that is more of a flat business, slightly up business long-term. It had been in decline, as you well know, and then as we recovered that through some great internal development efforts around BMC Performance Manager, new generation technology there and the BSM messaging and integration, we’ve seen that business improve but not at that level of improvement. That was primarily driven by large transactions that we were -- in period transactions.

Walter Pritchard - Cowen & Company

Great, and then Steve, maybe if you give us just on the financing receivables, just how much you sold in the quarter and what your expectation is there for the year versus where it was last year.

Stephen B. Solcher

Okay. In the quarter, we did about $100 million of monetizations. You know, for the full year we are still thinking that number is going to be higher than last year. It will kind of grow as bookings grow.

One thing I would like to spend a little bit of time and just point out is we don’t look at monetizations as a key metric like we used to in the past. We are thinking about -- you know, the way a customer chooses to pay for a transaction, we’re largely indifferent. So whether they pay for it cash up front or they find their own financing or we finance it and monetize it later, we are really not as focused on that as we have been in the past.

I would tell you that we are more focused on the quality of the booking and the fundamentals of the business underlying that. So what is the term length of the transaction, is it license or maintenance, and less so about the financing itself.

Walter Pritchard - Cowen & Company

Great. Thank you very much.

Operator

We’ll go next now to Kevin Buttigieg at AG Edwards.

Kevin Buttigieg - AG Edwards

Thank you. Bob, I was wondering, IBM’s MIPS shipments have been strong and IBM has obviously been talking a lot about Linux on the mainframe as being a key driver for some of their MIPS growth. In what ways do you participate in that aspect of growth? Is it in site-based licenses or are you putting a lot of product on top of the Linux operating system?

Robert E. Beauchamp

We have some on top of the operating system. I wouldn’t say it’s material at this point. It is something that we support, so if the customer uses that and to the extent that we are an enterprise say in the main view business, we want to be able to monitor the business. We want the ability to span into those areas.

But we do not have a significant product suite focused on Linux on the mainframe. We do see Linux on the mainframe keeping the, benefiting the Z series platform in general. It’s just keeping that platform out there, even though it’s a different OS. So it is just generally a positive for the platform itself, which ultimately drives more revenue for us.

Kevin Buttigieg - AG Edwards

Okay, and then Steve, or actually Bob, you had mentioned continuing to do acquisitions. Although you’ve done a couple of acquisitions, most of them have been small and they sort of have not been a tremendous number of acquisitions. Do you just foresee maintaining that type of acquisition strategy or do you see it actually picking up in terms of number of transactions or size of transactions?

Robert E. Beauchamp

I don’t know that I could give you specific guidance on the number but I would say that in general what you’ve seen is what we like to do. We like to do these targeted acquisitions, precision acquisitions that give us competitive advantage on the roadmap for BSM. We have the next generation of BSM clearly mapped out. We’ve been marching to that acquisition. The RealOps acquisition, which I will tell you, by the way, is already integrated into our CMDB 2.0 today in production at customers, is the type of acquisition I love to do. It adds a business process layer to the enter BSM story and continues our march as we move up stack on BSM.

Larger transactions are certainly possible but we will look very carefully at each of those transactions before we would move into something that was very large. We’d be very thoughtful before spending that kind of money.

Kevin Buttigieg - AG Edwards

Okay. Thanks very much.

Operator

We’ll go next now to Derek Bingham at Goldman Sachs.

Derek Bingham - Goldman Sachs

Thanks for taking my question and congratulations on the quarter. My first question is on your buy-backs and I’m wondering if it’s the right way to think about it, that you return to the $100 million, $150 million a quarter pace that you were at prior to this past quarter.

Stephen B. Solcher

I would tell you that I would say on the north end of that range is what I would forecast for the second quarter.

Derek Bingham - Goldman Sachs

Okay, great. And then, I’m also curious on contract length in the quarter and how that’s been trending. You’ve given good granularity on how those, kind of from a trailing 12-months basis how that has trended but with annualized lagging, when you look at it on an annualized basis, do those start to converge at some point, where we start to normalize? Or do those continue to grow for the foreseeable future in terms of contract length?

Stephen B. Solcher

Actually, on the contract length for the full year you should expect the contract length to actually shrink. What we had is we had a couple of tough compares in the third and fourth quarter of last year that, as you mentioned, on a trailing basis are going to stay there.

I will tell you that as ESM becomes a bigger piece of the pie, the composition, that you are going to see the overall contract length for the company continue to shrink. So even though we are forecasting low single digit growth rate on absolute bookings, on an annualized basis you should see that be pretty healthy, in the double-digit range.

Derek Bingham - Goldman Sachs

Double digits for the full year bookings?

Stephen B. Solcher

For the full year, yes -- on an annualized view, yes.

Derek Bingham - Goldman Sachs

Okay, and then last one, if I could -- obviously you are rolling off the Identify acquisition and that dampened the BSM license bookings a little bit, which had been benefiting from that. But is double-digit still the right way that you think about license bookings in BSM going forward?

Stephen B. Solcher

Yes, I would say that it would be similar to that of last year. We really had no impact, no real impact this quarter from Identify, so the rate you see is what you -- there wasn’t a positive impact from it but going forward, I would say on the license booking side, you should see something in the low teens.

Derek Bingham - Goldman Sachs

Okay. Thank you very much. Congratulations.

Operator

We’ll go next now to Israel Hernandez at Lehman Brothers.

Israel Hernandez - Lehman Brothers

Good afternoon, everyone. Congratulations. Can you talk about the pipeline of big deals heading into the balance of the year, particularly as we may be going into a bit of a more of a volatile market, particularly in the financial services verticals. I wanted to gauge how you guys are looking at your big deal pipeline for the remainder of the year.

Robert E. Beauchamp

We feel good about the pipeline in general for the rest of the year but the big deal pipeline is not as strong as say, for instance, last year’s pipeline in the second half. We had a really strong second half last year. This year, as we guided 90 days ago and again today, the first half of this year is a little stronger on a relative basis. So we are looking for a solid second half but not as many whales floating around out there in the second half of this year. That’s included in the guidance. There’s no change there. There’s nothing -- there’s no new news there. That was in the guidance we gave when we set guidance originally.

Israel Hernandez - Lehman Brothers

Thank you.

Operator

We’ll go next now to Brendan McCabe at CIBC World Markets.

Brendan McCabe - CIBC World Markets

Just a quick question on the strength in the U.S. Were you surprised by that, and what would you really attribute it to?

Robert E. Beauchamp

No, not surprised by it. The U.S., we did great in federal. We just had some really solid performance. We’ve got a good management team, some of them new, have been in about a year now and some of that effect is taking place. We had some very, very nice systems integrator outsourcer business. Really, really strong growth as the BSM has been working there. We’ve just seen some nice growth in that, and those are U.S.-based companies.

Brendan McCabe - CIBC World Markets

Great, thanks.

Operator

We’ll go next now to Tom Curlin at Royal Bank of Canada.

Tom Curlin - RBC Capital

Good afternoon. Can you give us your perspective on how the competitive environment is evolving in the BSM segment, with HP having recently acquired Mercury and Peregrine and so forth, and then now bringing in Opsware. Have you seen any change in competitive engagements or behavior now that those things are part of HP? How would you describe that situation now versus a year or 18 months ago?

Robert E. Beauchamp

Okay. I think the difference say 18 months ago was that many of our competitors were attempting to say that BSM was not their strategy, that there was some other strategy. In the last 18 months, that’s all gone away. They are now all basically adopting the exact same strategy. If you listen to the earnings calls and you listen to the comments, the marketing comments of our competitors, they are all essentially talking about configuration management database. They are talking about service management. They are talking about integrated service management.

So the competitive positioning is really coalesced around the strategy that BMC announced in April of 2003 with BSM. It is very, very similar competitive positioning in the market, which is why we are not standing still. It is also why we feel extremely good about Gardner recently suggesting that BMC was more than 18 months still in the lead on technology, why Forester recently said similar comments, that BMC is clearly the inventor of BSM and the lead on this. So we are advancing on that lead.

What I would tell you is just as an aside is when we looked at the companies that were going to buy, that could buy Opsware, I think it is safe to say it ended up in the place we most hoped it would end up -- a company that already has three or four different provisioning software products in place that they’ve sold to different customers, a company that now has I think three or four different CMDBs, multiple service desks, and frankly a gigantic integration problem on their hands, both from technology sales and the like.

So from that standpoint, we don’t dismiss them. The competitors out there certainly, we fight with them every day but I do think that by BMC being very focused, trying to have one of everything instead of two or three of everything, is the right strategy. It gives us the reason why we already have customers in production today running the CMDB 2.0 in production today with BSM suites in place, and why we see virtually no production competitive environments today with configuration management database running multiple applications.

So from that standpoint, the rhetoric is the most competitive it’s been in years. The reality is they are chasing the strategy that BMC is probably two years ahead on.

Tom Curlin - RBC Capital

Have you found Peregrine customers to be -- has it been even perhaps a catalyst for you, or is that just very sticky business, the fact that they may face a major transition to a Mercury CMD or CMDB or -- I don’t know, to some degree, something from Opsware over time? Does that matter in competitive engagements for you now, the transition they may have to go through or is it just very sticky business?

Robert E. Beauchamp

No, it matters greatly. One of the largest transactions we’ve done in the last year was a customer who had made the decision to move off of that service desk and move to ours. Our briefing center, our brand new briefing center -- which we look forward to giving tours to all of you for our investor day, which is November 15th, by the way. We hope you are all here in Houston for that. We’ll give you a tour of our new executive briefing center -- is frequently full of customers and it is very often that the topic of discussion is competitive replacement for one of the multiple help desk and service desks that HP and our other competitors have.

Tom Curlin - RBC Capital

At the right price, do you view an Opsware like capability as something that would complement what you are already doing, or do you feel like you -- I’m sorry. Go ahead.

Robert E. Beauchamp

There is more than one technology there. As you know, when we acquired RealOps, we picked up the market leader, or as you may not know or you may, we picked up the market leader in run book automation, which is one of the technologies involved there. That technology is well integrated into the core competitors of some of the other offerings and the pieces that were part of Opsware.

Tom Curlin - RBC Capital

Yes, I’m speaking more to the application, the server stack mapping capabilities, and I guess to some degree rendition on the network config side. The storage stuff was very early but more of the after server, after network capabilities.

Robert E. Beauchamp

Yes, and the run book automation component, and so I would -- the answer to that is that without giving out too much broadcast of our product plans, our internally developed product plans and some of the strategies we’ve got in the near future, I would tell you that there are pieces of that that we are targeting and that we have underway right now and for internal development. There are components that may be filled through acquisition and that we think that we’ve got some strong competitive advantage just as we stand today in many of the components that make up a full business service management environment, of which that piece is only one very tactical piece.

Tom Curlin - RBC Capital

Great. Thank you very much.

Operator

We’ll go next now to Kirk Materne at Banc of America.

Jeffrey Constantino - Banc of America

Hi, guys. It’s Jeff Constantino dialing in for Kirk Materne. On the operating margin improvement, can you quantify or give us some idea of how much of the improvement came from the distributed side of the business versus the mainframe? Also, can you just talk about whether we can expect further margin upside going forward from here to be primarily due to better leveraging the distributed business? Thanks.

Stephen B. Solcher

The margin improvement in the quarter primarily came from the ESM unit, and you should expect that to continue to improve as we move through the rest of the year.

Jeffrey Constantino - Banc of America

Perfect. Thanks, guys.

Stephen B. Solcher

In terms of the rest of the year, we also will improve off the operating margin of Q1, if that wasn’t clear.

Jeffrey Constantino - Banc of America

Right.

Operator

We’ll go next now to Tim Klasell at Thomas Weisel.

Tim Klasell - Thomas Weisel

I’ll throw out my congratulations on the quarter as well. Two quick questions, first just a housekeeping one; Steve, can you give us the currency impact on the quarter?

Stephen B. Solcher

Currency to revenues was a little less than 1%.

Tim Klasell - Thomas Weisel

Okay, good enough. And on the earnings?

Stephen B. Solcher

And on earnings, about 2 percentage points.

Tim Klasell - Thomas Weisel

Very good. And then, sort of a high level question now; in the past, you’ve been rather consistent in saying that the MSM business probably would be flat to slightly growing and you’ve been beating that a little bit here over the last few quarters. Do you think it’s just a cycle or is growth sustainable here? And could we see a change in strategy of how much you invest in that business, either through R&D or acquisitions or what have you?

Robert E. Beauchamp

Well, we’re obviously pleased with the performance that the mainframe group has delivered. We haven’t yet become comfortable in changing the long-term growth trajectory of that market yet. I think that if that continues, if we continue delivering these sort of results, we’ll have to revisit our long-term forecast for the market. There are some positive indicators, like I said before. You’ve seen some analysts out there talking positively about the MIPS shipments. You see IBM being more positive about it. You see us winning some competitive wins, replacements.

So while it is positive, we’ve got -- we’re not ready yet to change the long-term trajectory of that market. I think we just need to stick with projections as we have, as we’ve given so far.

Tim Klasell - Thomas Weisel

Okay, and then you mentioned a little bit on the main view product and your database tools. On the mainframe side, are they growing in parallel or is one of those product lines growing faster than the other?

Robert E. Beauchamp

In parallel.

Tim Klasell - Thomas Weisel

Thank you.

Derrick Vializ

Operator, do we have anymore questions?

Operator

It looks like our last question today will come from Richard Sherman at MKM Partners.

Richard Sherman - MKM Partners

Hey, Bob, good afternoon. A question on some of these bigger industry trends, and I know you’ve got some interesting things working in the pipeline on the product development side but maybe talk a little bit about, maybe even anecdotally, about how the identity management portfolio is driving your business, or if it is not, and how that shapes your prospects for the second half of the year? And then maybe a little bit about some areas that obviously I’m sure are on your roadmap -- virtualization and networking, if you could maybe talk about that.

And then just on -- Steve, I missed the ratable number. Could you repeat that number?

Stephen B. Solcher

The ratable percentage in the quarter was 58.

Richard Sherman - MKM Partners

Thank you.

Robert E. Beauchamp

All right, so I’m going to try to collect those questions. In terms of identity management, that was the first one, I would say that it is a nice-to-have, not a have-to-have, part of the overall strategy, in that customers -- it is more and more being discussed as part of ITEL Version 3. Identity management has made its way into kind of the discussion around long-term ITEL methodologies.

But we haven’t seen in a real sense customers insist upon identity management as part of an overall BSM environment. We see some synergies between the two and we obviously play to those synergies but they are usually discrete transactions, where identity management is the subject and it is the only subject with a unique buyer, the buyer being in the security management area of the firm.

It is nice to have. It is some powerful technology but it is reasonably discrete from the BSM story on a day-to-day basis as we actually sell our technologies.

Virtualization and SOA and the big drivers I think is a powerful reason that BSM is such a hot topic. If you think about what SOA brings, it brings dramatic increases in the number of changes that are going to occur in a production environment to an enterprise, really moving it to almost immediate sort of changes, constant changing to applications.

Virtualization, the same thing except on the image side you have the ability to spawn new servers, virtual servers without -- forget the physical server producing like we just talked about a moment ago -- new virtual servers spawning in and out of existence and having to be configured and changed. The number of servers as a result of that, the virtual servers which have to be managed like physical servers, just skyrockets.

So for us, as we talk to our customers in the briefing center, it is a simple question; how do you intend to manage this level of complexity, this many new servers, this much change management processes if you do not have a centrally managed configuration management database keeping track of all of the images, all of the elements, and all of the changes?

And the reality is you can’t. I would propose to you it would be impossible for a large enterprise to embrace virtualization and SOA methodologies without having BSM as the core management layer because the manual and silo-based processes of the past simply will not scale in that sort of much higher volume change process and much higher number of units that you are having to manage.

In terms of networking, we still view networking as a very interesting space that we constantly evaluate. We do have networking technologies but we do not have a large presence in the network management space. There are some very exciting new technologies coming out. There are some great ideas coming out of our labs on how to add more networking capabilities to our product lines.

I would expect to see us more engaged in the network business through both internal development and potentially through acquisition, although at the very least through internal development within the next year.

Richard Sherman - MKM Partners

Very good. Those are my questions. Thank you.

Robert E. Beauchamp

Okay, so concluding remarks, let me just make a couple of comments. One, just a reminder again, November 15th, BMC Investor Day will be here in Houston. Number two, I want to thank our employees for all their hard work. And third, I want to tell you that our conference operators informed us that one or more of the participants’ lines were opened prior to the call starting. At no time were the BMC lines open, so you were not listening to Steve and I, fortunately, but you were listening to each other, apparently. So for that, we apologize. We will be talking with our conference provider to find out what’s the matter with their quality initiatives internally and we’ll see if we can’t improve that. So I apologize for that.

Thank you all and we look forward on to Q2. I will tell you that the pipeline in Q2 looks strong. Thank you all very much.

Operator

And again, that does conclude our conference. We thank you all so much for joining us and wish you all a great remainder of your day. Goodbye.

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Source: BMC Software F1Q08 (Qtr End 6/30/07) Earnings Call Transcript
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