Research Analyst: Jyoti Lakhotia, M.Fin

March 07, 2007

Research Analyst: Jyoti Lakhotia, M.Fin.

Sr. Editor: Ian Madsen, CFA: : 1-800-767-3771; x417

111 N. Canal Street, Suite 1101  Chicago, IL 60606

Hyperion Solutions Corp. (HYSL - NASDAQ)

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$51.55

Note: All new or revised material since the last update ishighlighted.

Reason for Report: Oracle buys Hyperion. (Prev: 2Q07 Results, Jan 26)

Overview

California-basedHyperion Solutions Corporation (HYSL) provides business performance management (BPM) software for various corporations worldwide. Its solutions enable customers to collect, organize, and analyze data from various transaction systems, such as accounting, billings, bookings, supply chain, sales force automation, and call centers. The company’s products include financial and operational applications, and a business intelligence (BI) platform including Hyperion Planning, a Web-architected application, which helps coordinate and manage various elements of the planning, forecasting, and budgeting cycle; Hyperion Strategic Finance, a financial modeling application that provides analysis of alternative strategies tocorporate development, finance, and treasury executives; Hyperion Financial Management that delivers financial consolidation, reporting, and analysis in a single solution; Hyperion Performance Suite, which uses a services-oriented architecture to deliver Web-based query, analysis, and reporting of databases; Hyperion Essbase that delivers services to access and integrate data and metadata from a range of sources, perform analytical processing, and deploy business performance applications; Hyperion Master Data Management Server, an architecture for synchronizing BPM master data across multiple enterprise systems; and Hyperion Hub, a centralized metadata manager. For more information about the company visit

On March 01, 2007, HYSL announced it has agreed to be acquired by Oracle Corporation through a cash tender offer of $52.00 per share, or approximately $3.3 billion. The acquisition of Hyperion will make Oracle the category leader in the high growth enterprise performance management market. The transaction is subjected to customary conditions, including regulatory approvals, and is expected to close in April 2007.

Key Positive Arguments / Key Negative Arguments

• HYSL continues to benefit from a strong license business, and a strong performance in the Americas.
• HYSL, with its BPM software and other products, is expected to benefit from the SOX-related software solutions roll out.
• System 9 will allow HYSL’s sales force to more effectively lobby customers to standardize on HYSL as their sole BI vendor.
• The Decisioneering acquisition should bolster HYSL’s planning and also tools franchise with the addition of predictive analytic capabilities.

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• Weak technology spending environment would dampen growth and operating margin expansion.
• Overall topline growth of the company is below peer group average.
• Upcoming release of Microsoft's BI in Office 12 is a major threat. Analysts believe the query and reporting market will become more challenging once Microsoft ships Office 12, since it will bring some additional pricing pressure to companies with a large query and reporting exposure like HYSL.

HYSL’s Fiscal Year ends on June 30.

Recent Events

2Q07 Results

On January 23, 2007, HYSL reported financial results for 2Q07. According to the press release, the company reported EPS of $0.50 and total revenue of $222.9 million versus consensus EPS estimate of $0.44 and $212.0 million, respectively.

Hyperion to Acquire Decisioneering

On January 23, 2007, HYSL announced a definitive agreement to acquire Decisioneering, privately held decision analysis software and solutions company headquartered in Denver, Colorado. Hyperion will operate Decisioneering as a stand-alone Hyperion business unit. Decisioneering's award-winning software, Crystal Ball, is the industry-leading predictive analytics, simulation and modeling tool built for business users.

Hyperion and HyperRoll Establish Partnership

On October 10, 2006,HYSL announcedits partnership with HyperRoll, Inc., a leading provider of high-performance data aggregation software for business intelligence (BI) applications. The partner agreement is part of a mutual resolution of patent litigation between the two companies, which also includes a technology cross-licensing arrangement, and an equity investment by Hyperion in HyperRoll. The multi-year alliance includes a close collaboration between the two companies that will be focused on bringing together HyperRoll technology and Hyperion System 9 components.

Hyperion and Movaris Announce Strategic Partnership

On October 10, 2006, Hyperionand Movaris announced a strategic partnership to market integrated solutions that address the critical issues associated with the 'last mile' of finance. The 'last mile' refers to the series of steps and activities involved in the financial close, from consolidation through a company's public disclosure of its financial results, including filings with the SEC. The process of preparing financial statements is the final opportunity to identify and address the issues or errors that could later result in a restatement of financial results.

Revenue

Revenue ($M)– FYJune 30 / 2Q07A / Q/Q% Change / Y/Y% Change / 2006A / 2007E / 2008E
Software Licenses / $84.8 / 24.6% / 14.0% / $295.1 / $332.7 / $362.4
Maintenance and Services / $137.8 / 5.5% / 24.0% / $470.3 / $555.8 / $610.1
TOTAL REVENUE / $223.1 / 12.2% / 20.3% / $765.4 / $891.6 / $973.0

The Zacks Digest average total revenue for 2Q07 was $223.1 million (vis-à-vis company’s results of $222.9 million), up 20.3% y/y and 12.2% sequentially. The results comfortably passed the Street estimates of $212.0 million based on the success of System 9. This is the third consecutive quarter of double-digit license revenue growth, fueled by increasing demand for Hyperion System 9, which bodes for the remainder of the year as the product continues to pick up momentum in the marketplace.Software license revenue accounted for 38.3% of total revenue while Maintenance and Services revenue contributed 61.7% of total revenue.

Revenue Breakdown by Segment:

During the reported quarter,Software Licensecame in at $84.8 million, up14.0% y/y and 24.6% sequentially based on continued progress in System 9 product cycle and strong contribution from new customers. One analyst (ThinkEquity) attributed the outperformance to better-than-expected contribution from Upstream, favorable 1Q seasonality, and mildly better sales execution. The analyst estimates that organic license revenue growth net of the 3Q recovery and Upstream was roughly 10% y/y, which is not spectacular but still encouraging given overall BI growth rates.

System 9 was the predominant contributor to this quarter’s strong results. Most analysts believe with System 9 being a major product cycle, some customers may be holding off on purchasing older products (HPS, Essbase etc.). Of the second quarter’s top ten deals, more than 76.0% of total license revenuescame from System 9. Althoughthe company faced competition within the BI market from independent vendors (Business Objects andCognos) and large software vendors(Microsoft, Oracle, and SA), Hyperion’s averageselling price increased to $131,000, versus $118,000 in 2Q06.

According to management, Hyperion has penetrated only 8.0%–10.0% in the installed base for Systemupgrades and appears to have a significant opportunity for further growth. So analysts believe the resurgence in new customer license contribution appears to be a leadingindicator of future cross selling opportunities.

In addition to the System 9 product cycle, one analyst (Goldman) believes that Hyperion continues to benefit from cross selling complementary acquired products including those from Razza (master data management) and Upstream (data quality). Hyperion announced its plan concurrent with the 2Q report to acquire another private software vendor Decisioneering. Decisioneering provides predictive analytics tools which can be used to perform simulations and test assumptions as part of the broader Hyperion business modeling and performance management processes. Hyperion expects Decisioneering to add about $6.0–$8.0 million toFY07 revenue, but did not disclose terms of the transaction. The firm expects Hyperion to continue to make acquisitions. The firm, however, believesthat since Hyperion’s strategy is focused on small complementary products it should reduce acquisition related execution risks and enhance cross selling opportunities. Management noted strong master data management (MDM) and financial data quality management (FDM) activity, and highlighted an attractive cross-sell activity ahead. Hyperion has added 407 new customers, 50.0% more than the 272 added in the previous quarter. New customers contributed 27.0% of License revenue.

Maintenance and Servicescame in at $137.8 million, up 24.0% y/y and 5.5% sequentially. Analysts believe the renewed emphasis on the services business led to outperformance by the company in the Services segment. However, the gains resulted largely from better utilization rates of existing resources, and are expected to perform in the current trend.

Revenue Breakdown by region

Hyperion Solutions posted strong growth in the EMEA region, up 26.0% y/y and contributed 34.0% of total revenue. Contributing to the upside was the closure ofthe largest transaction ever for Hyperion’s EMEA region (second largest for the company),which helped to generate record license and total revenues. In addition togood execution, management further noted seeing an improving macroeconomicenvironment across all the major European countries. This is consistent with other software vendors including SAP and Oracle who have also seen improvement in theirEMEA businesses. Hyperion also posted good results from the Americas region, up 20.0% y/y and contributed to 60.0% of total revenues. In contrast to the positiveperformance in the Americas and in EMEA, business in the APAC region was weak as it shrank 3.0% y/y and accounted for 6.0% of total revenue. Managementattributed the weakness to a difficult comparisongenerally lumpy large deal closure in a small region, and particular weakness in Australia. Management did comment that Japan was a relative bright spot in the region, consistentwith recent comments from IBM.

Outlook

According to one analyst (First Albany),2Q07 is one of the strongest quarters from Hyperionuntil now. The analyst believes that the Street is substantially underestimating the revenue and EPS growth that Hyperion can generate. The results appear to indicate that the typical issues surrounding new product cycles, as well as minor company-specific obstacles, such as those surrounding HYSL's introduction of its ‘enablement fee,’ have begun to subside. The implication is that customers are now seeing a compelling value proposition in moving to System 9.

Another analyst (Goldman) states that although Hyperion posted solid results, the risk going forward is increased seasonality in the business weighing on near-term growth. It appears that the software business is becoming more seasonal, with many customers holding off purchases until year end. The analyst observed that other business intelligence vendors that are in the midst of significant product cycles, including Business Objects and Cognos, are reporting increased revenue contribution from the installed base while contribution from new customers is decreasing. While the analyst believes that Hyperion is relatively better insulated to increasing competition versus its BI peers, given the company’s market leading position in financial analytic applications, lower new customer contribution could point to increasing competitive encroachment in new deals.

One analyst (Pacific Crest) believes that Hyperion’s core business performance management (BPM) should benefitfrom increased corporate requirements around regulatory compliance and data governance. In addition, Hyperion’s core BPM business remains the least vulnerable tocommoditization that is likely to affect the broader BI market.

Please refer to the Zacks Research Digest spreadsheet on HYSL for a detailed sales breakdown and future estimates.

Margins

MARGINS - FY June 30 / 2Q07A / Q/Q Change / Y/Y Change / 2006A / 2007E / 2008E
Gross / 74.9% / 1.8% / 0.5% / 75.9% / 74.7% / 74.9%
Operating / 17.8% / 4.0% / 0.6% / 16.4% / 16.7% / 17.8%
Pre tax / 19.8% / 4.1% / 1.1% / 18.3% / 18.0% / 19.8%
Net / 12.8% / 3.0% / 0.8% / 11.9% / 11.5% / 12.8%

The Zacks Digest average gross margin for 2Q07 came in at 74.9% (vis-à-vis the company results of 73.7%), up50 basis points y/y and 180 basis points sequentially, with topline responsible for most of the expansion,though HYSL continued to witness weakness in service margins as a result of lower internal utilization rates which necessitated the company resorting to third-party consultants. Management is maintaining a specialist team approach to address expanded product offerings to maintain focus among the core sales force. Hiring remains a challenge in a competitive market, but management appears to be on plan for hiring into FY07.

Operating margin in 2Q07was 17.8% (as compared to 13.5% announced by the company), up60 basis points y/y and 400 basis points sequentially. Research and development expenses increased to 13.0% in the quarter due to increased headcount in the company’s internal development team and investments in offshore R&D contract personnel to support the release of System 9 version 9.3. General and administrative expenses increased 11.0% y/y primarily due to higher headcount and investments in process improvement and systems infrastructure.

Outlook

Large firms with deep financial pockets, domain expertise, and large customer bases are considerably wellpositioned to beat Hyperion in this market. In this regard, analysts remain apprehensive about Hyperion’s R&D budget, which is far less than that of the major players. In addition, Hyperion has been known to suffer from sub-optimum sales execution and financial volatility. Going forward, one broker (JMP Sec.) believes that Hyperion will need to demonstrate better expense control as it scales the business in order to gain credit with investors. It remains concerned that Hyperion might make a significant business intelligence acquisition in order to gain scale, introducing new integration risk into the story. While Hyperion’s revenue performance in the past two quarters has been strong, the fact remains that Hyperion holds the undesirable third place slot in an increasingly competitive sector. Such an acquisition could help Hyperion leapfrog the competition, much as Business Objects has done with its acquisition strategy over the past few years.

While management was upbeat on System 9 activity, one brokerage firm (ThinkEquity) believes that the product cycle might not drive significant reacceleration of the margins due to several reasons:

Though System 9 positions Hyperion well for standardization decisions, other close BI peers are also better positioned with their versions of an integrated platform. Given the prospects of toughening competition from Microsoft and other global stalwarts, the firm anticipates standardization decisions extending in sales cycles and, thereby, slowing growth.

The macro economic environment is relatively volatile, which could constrain growth rates unless HYSL witnesses some notable share gains in 2007.

System 9 is more of architecture release than a functional release, which could slow upgrade activity, and exert some pricing pressures.

The Zacks Digest operating income for 2007 and 2008 are projected to be $147.6million, and $172.6 million, respectively, reflecting an increase of 17.5% in 2007 and 16.9% in 2008. The estimated 3-year CAGR based on realized 2005 operating income is 15.3%.

Please refer to the Zacks Research Digest spreadsheet on HYSL for more details on margin estimates.

Earnings per share

Pro Forma EPS-FY June 30* / 2Q07A / 3Q07E / 4Q07E / 2006A / 2007E / 2008E
Zacks Consensus / $0.35 / $0.45 / $1.42 / $1.65
Company Guidance / $0.40-$0.45 / $1.80-$1.85
Digest Average / $0.50 / $0.43 / $0.56 / $1.54 / $1.82 / $2.05
Digest High / $0.50 / $0.45 / $0.61 / $1.55 / $1.91 / $2.25
Digest Low / $0.40 / $0.34 / $0.46 / $1.22 / $1.44 / $1.71

*Zacks consensus is GAAP, all other estimates are proforma

The Zacks Digest average proforma EPS in2Q07 was $0.50 (inline with the company’s results), up 33.9% y/y and 45.9%sequentially. The results came in ahead of the consensus estimate of $0.44. The company had a $0.02 benefit from lower-than-expected tax rate while the remaining upside stemmed from operating leverage. GAAP net income for 2Q07 was $21.5 million, yielding GAAP EPS of $0.36 per diluted share, compared to net income of $15.5 million, or $0.25 per diluted share, for 2Q06.

The reconciliation between GAAP and non-GAAP EPS is illustrated in the table below:

Outlook

Based on stellar performance in 2Q07, management’s upbeat tone and bullish guidance, and broadening product portfolio, many analysts have increased their respective EPS estimates.

In conjunction with its earnings release, HYSL announced that it has agreed to acquire privately held Decisioneering Inc., a provider of risk analysis software. While the terms of the transaction were not disclosed, the effect on non-GAAP EPS for FY07 is expected to be neutral. One analyst (Cowen) views the Decisioneering’s predictive analytics technology as a strategic complement to the existing product lineup of HYSL. Predictive analytics is used in advanced planning and forecasting, and is the least commoditized area in BI that promises the mostgrowth. The acquisition is expected to be dilutive by $0.02 and $0.01 in 3Q and 4Q respectively due to restructuring charges. Another analyst (J.P. Morgan) views the acquisitions favorably as they are small tuck-in technology acquisitions offering complimentary technologies with relatively low integration risks and HYSL has a good track record with similar sized acquisitions that accelerate growth.

In early CY06,HYSL announced the acquisition of Upstream Software, a vendor of data quality solutions targeted for financial information. Upstream has been Hyperion’s partner since 2002, and the solutions are designed to work together with the Hyperion products. The deal gives Hyperion the first BPM vendor with a packaged data quality solution, tailormade for financial data quality management. Forrester Research estimates the size of the 2006 financial data quality managementmarket at $407.0 million, with an estimated 17.0% CAGR. While analysts expect the deal to be modestly beneficial to HYSL, management believesthe deal will be accretive to non-GAAP EPS.

The Zacks Digest brokers expect Hyperion System 9 to continue to drive earnings growth in the nearterm and to be a key for strengthening long-term business ties. The company continues to run cash-flow positive, and analysts expect it to use this cash to buy back shares and to make small add-on acquisitions.

The Zacks Digest model projects EPS of $1.82 and $2.05 with a y/y increase of 18.6% and 12.4%, in 2007 and 2008,respectively. Estimated 3-year compounded annual growth rate (CAGR) based on 2005 EPS is 17.2%.