Borland Software Corporation Q3 2008 Earnings Call Transcript

| About: Borland Software (BORL)

Borland Software Corporation (BORL) Q3 2008 Earnings Call Transcript November 6, 2008 8:00 AM ET


Aaron Feigin – VP, Corporate Communications

Tod Nielsen – President and CEO

Erik Prusch – SVP and CFO


Sanjay Puri – Walker Smith Capital


Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Borland third quarter 2008 results conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator instructions) The conference is being recorded today, Thursday, November 6 of 2008. At this time, I’d like to turn the conference over to Mr. Aaron Feigin, VP, Corporate Communications. Please go ahead, sir.

Aaron Feigin

Thank you, Vince. And good morning. Discussing Borland’s results today will be Tod Nielsen, President and CEO, and Erik Prusch, CFO. Before we begin, however, it’s important to mention that our comments today may include forward-looking statements that involve risks and uncertainties.

For a discussion of such risks and uncertainties, please refer to today’s press release as well as our most recent annual report and quarterly report on forms 10-K and 10-Q filed with the SEC. These may be obtained at Please be cautioned forward-looking statements are not guarantees of future performance. Actual results may differ materially from management expectations. Borland undertakes no obligation to update any information discussed on this conference call.

In today’s discussion of third quarter 2008 results, we will provide non-GAAP financial data. We refer you to today’s press release for a more complete discussion of our non-GAAP financial data, including the reconciliation of such non-GAAP data to the applicable GAAP financial measures and information about forward-looking non-GAAP financial data.

Now, I will turn the call over to Tod Nielsen, President and CEO of Borland. Tod, please go ahead.

Tod Nielsen

Thank you for joining us this morning. I’m going to briefly review Borland’s Q3 performance and the state of our business before handing the call over to Erik for the financial review.

We generated approximately $44 million of revenue in Q3. This represented $35.5 million in ALM revenue and $8.8 million in DPG and other revenue. On a non-GAAP basis, Borland had operating income of approximately $400,000 with a net loss of $0.01 per share compared to an operating loss of $4.6 million or net loss of $0.09 per share in the previous quarter. Erik will discuss the GAAP performance in his section, which will include a summary of one-time expenses, the impact of our additional debt repurchase activity, and the goodwill impairment charge.

Overall, I’m pleased with our progress. We grew ALM license revenue each of the last two quarters and generated a positive non-GAAP operating income this quarter. I believe our operating foundation is solid and we are well positioned to withstand uncertainties of the global economy.

On our last quarterly call, I reviewed our two-part plan for achieving sustainable, long-term, profitable growth. First, continuing our efforts to reduce operating expenses. We are making significant progress on those fronts and are ahead of schedule in cleaning up decades of sprawl. There are still more opportunities for us to continue our cleanup efforts, but I’m very pleased with our progress.

The second part of our 2008 plan is to pound away at refining a go-to-market model that can deliver predictable revenue from our existing products while preparing our organization to sell our next generation management products. In Q3, we shipped [ph] the cornerstone of our go-forward strategy and the most important innovation organically developed within Borland in years, the Borland Management Solutions. It’s the software industry’s first software delivery management system.

As I said on past calls, BMS is our solution to one of the biggest problems facing enterprise software organizations. That is, the lack of visibility and control of their delivery process. We received high accolades from Gartner publicly during the BMS launch in July. Now that the products are publicly available, others are starting to review and comment positively.

For example, Michael Azoff, an analyst with the UK-based Butler Group, wrote an in-depth report on Borland. And in that he said, “Borland is a leading vendor in the ALM tools market with a range of key tools. And now with the launch of BMS, it has again advanced the fields.” The continued affirmation from industry analysts as well as early customer feedback fuels our conviction that the ALM market is changing and that Borland is in a strong position from a vision and product perspective to execute on the opportunity in front of us.

With BMS publicly available, we are able to more confidently engage with customers and the industry on the issues driving change. Specifically, we are increasing our attention on the Agile wave I’ve discussed on previous calls. We continue to believe that Agile is getting significant attention within the enterprise. And as adoption grows, organizations will need to invest in new tooling, business process, and infrastructure.

BMS is positioned to serve this need and take a leadership position in what we believe will be a significant new component of the ALM market over the coming few years. This said, though in use by half a dozen companies already, BMS is a complex sell. And we expect to slowly ramp up sales in 2009 as we refine the product and enable our field to be successful.

In summary, our ALM revenue performance is improving, growing each quarter off the low point in Q1. There are two uncertainties, which make it difficult to set expectations several quarters out. First, we are conservative in estimating at what pace BMS begins to add materially to our revenue performance. And second, the unknowns associated with the global economy, which seem to be dampening outlooks for many. We are clearly competing in challenging times and we face the same near-term revenue challenges as our peers. But the efforts we put in to draw down the operating expense of our business, the new technologies we brought to market and our positive cash position are cornerstones in our ability to weather the storm and come out ahead.

Regarding our outlook, we previously set expectations for ALM and DPG revenue to be in the lower end of their range of $180 million to $200 million projected for 2007. Despite current economic conditions, we are not changing guidance. But we do acknowledge that our quarterly performance is dependent on our ability to close a number of pending, large transactions.

I’ll now hand the call over to Erik to provide a deeper dive on the financials and our efforts to improve our back office operations. Erik?

Erik Prusch

Thanks, Tod. I’d like to touch on a few of the key highlights from the quarter before I dive into the detail. First, we generated nice sequential growth in revenue of 5.8% led by ALM sequential growth of 11.2%. Second, as we committed at the beginning of the year, we again achieved our non-GAAP operating profitability target in Q3.

We generated non-GAAP operating income of $370,000. This also translates into EBITDA of approximately $1.4 million. Third, consistent with the last seven quarters we continued to reduce our operating expenses ahead of plan. Lastly, we successfully repurchased approximately $20 million in face value of our convertible debt for $15 million and generated a nice gain for the quarter.

Now moving into the detail. Total revenue for the third quarter was $44.3 million. This number excludes the CodeGear divestiture, which closed last quarter. This compares to $41.9 million reported last quarter. The prior year Q3 revenue was reported as $60.4 million, excluding CodeGear, and as you may recall, included two large ALM license revenue deals totaling $14 million in the quarter.

Enterprise revenue declined 26.7% year-over-year, but increased 5.8% sequentially. For the quarter, license revenue was $18.4 million, maintenance revenue was $20.2 million, and training and consulting revenue was $5.8 million. ALM revenue for the quarter totaled $35.5 million, which grew 11.2% versus the previous quarter, but was 25.1% below the prior year for the previously stated reason.

ALM license revenue was $13.8 million, showing growth of 37.9% over the previous quarter, but declining 41.6% from Q3 2007. ALM maintenance was $16.2 million, declining 3.1% from the previous quarter and declining 4.5% from Q3 2007. ALM training and consulting revenue was $5.5 million, growing 5.7% from the previous quarter and declining 18.6% from Q3 2007.

DPG and other revenue was $8.8 million for the quarter. As expected, this total declined 11.4% from the previous quarter and declined 32.6% from the previous year. We had one medium-sized ALM transaction in the quarter, but it was less than 10% of revenue.

Moving to gross margins, we had GAAP gross margins of 73.8%, 5.1 percentage points worse than the prior year, mostly driven by the deleveraging of $2.1 million amortization of intangibles due to the reduction in revenue as well as higher costs related to maintenance support. On a non-GAAP basis, our gross margins were 78.6% versus 82.5% in the prior year.

On a GAAP basis, our operating expenses totaled $142.5 million compared to $49.4 million in the prior year and $38.9 million in the previous quarter. On a non-GAAP basis, which excludes restructuring, impairment, stock-based compensation expense, and amortization of intangibles, our operating expense came in at $34.5 million compared to $37.5 million in the previous quarter and $46.7 million in the previous year.

As you can see, we continued to make good progress in improving our operating expense structure during the quarter. This is our seventh consecutive quarter of operating expense improvement. The majority of the improvement sequentially have been in outside fees for third-party service providers and reductions in compensation expense. In addition, we continued to make progress on our facilities reduction. We successfully sub-leased one of our two floors in our Belfast, Northern Ireland support center.

Turning to the bottom line, net loss on a GAAP basis for the quarter was $106.8 million or $1.47 per share. On a non-GAAP basis, we reported a net loss of $484,000 or $0.01 per share based on 72.7 million diluted weighted average shares outstanding for the quarter. Our GAAP net loss included stock-based compensation expense of $1 million, a restructuring credit of $85,000, amortization of intangibles of $2.2 million, impairment of $106.9 million, a gain on retirement of debt of $4.4 million, and discontinued operations of $576,000.

The largest item that impacted us in the quarter was obviously our goodwill impairment. The details for this are the following. The company performed its annual goodwill impairment testing on its single reporting unit, the enterprise business. The company used a two-part test required by FAS 142. First, to identify potential impairment, the company compared the fairly value of the reported units to its carrying value, including goodwill. The company used a combination of both income and market-based approaches in order to determine fair value. The income approach utilized projected future cash flows of the company, while the market of products was based on the company’s market capitalization. This analysis resulted in a conclusion that goodwill was impaired, which required the company to proceed with the second step of testing.

In the second step of testing, the amount of the goodwill impairment was determined by using an estimate of what the purchase consideration for the company might be in a theoretical sale of the company. The company used income and market-based approaches in the step, which involved a discounted cash flow analysis and a valuation analysis of intangible and tangible assets. These analyses also require management to make assumptions and estimates and review relevant industry and market data. As the result of the testing, the company recorded a non-cash goodwill impairment charge in the amount of $106.9 million as of September 30, 2008.

Now turning to the balance sheet, we had good performance during the quarter. First, we exited the quarter with cash and short-term investments of $166.8 million. Cash used in operations was $10.9 million in the quarter, which included approximately $2.5 million for interest payments on our debt, $5 million for previously earned bonuses, and $2.3 million for restructuring. In addition, we used $15 million to buy back debt. We believe we have done a good job in reducing our burn.

Accounts receivable at the end of the quarter was $33.6 million and DSOs were approximately 69 days, up 5 days from the previous quarter due primarily to one deal that was expected to be collected in the quarter that pushed to the third week of October. Despite this, we still had a very good quarter from a collections perspective and we were able to reduce our operating expenses by $400,000 through the reversal of some of our bad debt provision due to collecting a significant portion of our aged receivables.

Lastly, we still have approximately 100 reps worldwide, 34 of which are inside sales reps and 66 of which are direct account executives. Our preliminary maintenance renewal rate for the quarter was approximately 80%, which was led by our Silk and StarTeam product lines.

With that, I’ll turn the call back to Tod for closing comments. Tod?

Tod Nielsen

Thanks, Erik. In closing, we are in the third year of a multi-year transformation. I appreciate the hard work of our employees and the patience of our shareholders. We have made material progress every quarter this quarter and I expect to do the same in the fourth quarter of 2008. With BMS now being publicly discussed, we are beginning to deliver on the vision that has attracted so many talented people and innovative customers to Borland. Our ability to execute on this solid positioning will determine how bright our future is and how fast we can achieve sustainable growth and value for our shareholders. I look forward to sharing examples of our progress in upcoming calls.

With that, I’ll turn the call over to the operator for Q&A. Operator, please go ahead.

Question-and-Answer Session


Thank you, sir. (Operator instructions) And our first question comes from the line of Sanjay Puri with Walker Smith Capital. Please go ahead.

Sanjay Puri – Walker Smith Capital

Hi, guys, good morning.

Tod Nielsen

Hi, Sanjay.

Sanjay Puri – Walker Smith Capital

Nice job on growing licenses sequentially. Just a couple of quick housekeeping questions. First, Erik, do you have the maintenance number by any chance for the June quarter and the March quarter, please?

Erik Prusch

So from –

Sanjay Puri – Walker Smith Capital

For ALM.

Erik Prusch

For just ALM?

Sanjay Puri – Walker Smith Capital


Erik Prusch

ALM maintenance on the June quarter was $16.7 million and the March quarter was $16.5 million.

Sanjay Puri – Walker Smith Capital

Okay. All right, great. And then, Tod, you guys recently hired a new head of sales. Can you just talk about some of the initiatives they have put in place there? And within that question, can you talk about what’s happening within some of your geographies where you are seeing improvements and kind of getting things where you wanted to be or where there still needs to be some work-down, please?

Tod Nielsen

Sure. So –

Sanjay Puri – Walker Smith Capital

That’s my first question and I just have one more.

Tod Nielsen

Okay, sure. Rich started in July with us. He has done a good job of getting up to speed. He has been out all of the regions, met with our folks. We are working on kind of our refined 2009 go-to-market model. He has flattened the organization such that now he is rolling up his sleeves. Last week, he did a review of our entire Q4 pipeline and in detail walking through all of our significant opportunities. And so he is doing a great job of getting his hands around the operation is and what we need to do. We are in the process now of working on our 2009 plans and we’ll be having our rolling (inaudible) our field organization around the world at the beginning of next year. As far as where the geographies are, we are continuing to perform in the key areas we’ve been focusing on with respect to Germany and the UK and within the US. And then, Asia-Pac continues to be solid. And then finally, our inside sales group is continuing to do a tremendous job. They are delivering our value and doing what we need them to do.

Sanjay Puri – Walker Smith Capital

Do you see yourself adding more headcount or making any significant changes to sales in the next quarter or in ’09? I mean, how do we think about that? And then also, any notable wins in the quarter? You guys didn’t really – (inaudible) you talk about any notable wins or any notable opportunities. And then finally, can you just talk about what’s happening with EDS?

Tod Nielsen

Sure. As far as – I don’t see us doing any additions to headcount. I think we’ve got sufficient headcount. And so we are fine there. I think as far as notable wins, I don’t know of any particular customers off the top of my head, but I’m on the West Coast this morning. So it’s early, but we did good performance with our sequential growth. And then with respect to EDS, we are in negotiations with HP-EDS to talking about the next phase of our relationship and what that will look like.

Sanjay Puri – Walker Smith Capital

Okay, great. Thank you.

Tod Nielsen

Thanks, Sanjay.


Thank you. (Operator instructions) And we do have a follow-up question from the line of Sanjay Puri with Walker Smith Capital. Please go ahead.

Sanjay Puri – Walker Smith Capital

You guys don’t have to call me back later, I can just get all of my questions in now.

Tod Nielsen

Hey, Sanjay.

Sanjay Puri – Walker Smith Capital

The other question I had was, as you think about the fourth quarter, can you talk a little bit about where you see opportunities within ALM and within DPG as you look to the fourth quarter? And how do you think those materialize? I guess the real question is, how much of a stretch is it to get over the kind of goal line here, and how hard do you feel like you guys have to run? I realize the macro environment is not very encouraging.

Tod Nielsen

Yes, it’s one of the things we are focusing on our execution and what’s going on day-by-day. We have a number of deals out there. It’s got to be lumpy. And the macro economy will certainly impact. I mean, one of the things we’re looking for from customers is just what’s their situation as far as budgets and where it goes, and how Q4 is going to look, as well as what their thinking going forward. So that’s the state of it. We certainly have a chance, but it’s we are going to have to execute.

Sanjay Puri – Walker Smith Capital

Okay. Great. Good luck.

Tod Nielsen



Thank you. And at this time, there are no additional questions. I’d like to turn it back to management for any closing remarks.

Tod Nielsen

Okay. I’d like to thank everyone for joining us this morning and look forward to talking to you soon.


Thank you, sir. Ladies and gentlemen, if you would like to listen to a replay of today’s conference, please dial 1-800-405-2236 or 303-590-3000, using the access code of 11121523 followed by the pound key. AT&T would like to thank you for your participation. You may now disconnect.

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