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BEA Systems, Inc. (BEAS)

Q2 2007 Earnings Conference Call

August 16, 2006 5:00 pm ET

Executives

Kevin Faulkner - Investor Relations

Alfred Chuang – Founder, Chairman, CEO

Mark Dentinger – CFO

Analysts

Todd Raker - Deutsche Bank

Katherine Egbert - Jefferies & Company

John McPeake - Prudential Equity

Sarah Friar - Goldman Sachs

John Walsh - Citigroup

Robert Breza - RBC Capital Markets

Peter Cooper - Morgan Stanley

Terry –

Presentation

Operator

Good afternoon. My name is Marvin and I will be your conference operator today. At this time, I would like to welcome everyone to the BEA second quarter results conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session.

(Operator Instructions)

Mr. Faulkner, you may begin your conference.

Kevin Faulkner

Thank you. Good afternoon, ladies and gentlemen, and thank you for joining us as we discuss BEA Systems, Inc. results for the second quarter ended July 31, 2006.

Please note we posted our earnings press release on our web site at bea.com.

Statements made in the course of this conference call that are not of historical fact are forward-looking statements, including any statements regarding the plans, goals, strategies, opportunity and objectives for our business. In addition, statements that include the use of terminology such as may, will, expect, plan, estimate, continue, predict growth or other comparable terminology are forward-looking statements. Forward-looking statements also include statements regarding our financial guidance, including expected revenues and operating margins in our third quarter and any statements that could be construed as guidance regarding our future financial performance, potential effect of our stock option investigation, momentum and future adoption of SOA, BEA’s positioning in the SOA market, future customer results or implementations of our product, particularly our WLCP and RFID products, future product releases and any statement of assumptions underlying any of the foregoing.

Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those contemplated by the forward-looking statements. Such factors include those factors to be discussed by Mr. Dentinger today and those detailed in Item 1A, Risk Factors, on Pages 47 through 62 of BEA’s report on Form 10-Q for the fiscal quarter ended April 30, 2006, and similar disclosures in subsequent SEC filings.

The forward-looking statements and risks stated in this conference call are based on information available to BEA today. BEA assumes no obligation to update them.

BEA reports its results on a non-GAAP basis in addition to reporting results under generally accepted accounting principals. BEA’s non-GAAP measures exclude the impact of certain acquisition-related charges, employee stock option expense, net gains or losses on investments, net gains on repurchase of debt, facilities consolidation and other nonrecurring charges, and assumes a tax rate of 27%.

A full reconciliation to describe the difference between our non-GAAP and GAAP financial statements can be found in our earnings press release for this quarter, which is posted on the News and Investor Relations pages of our web site at bea.com.

Now I would like to introduce from BEA, Alfred Chuang, who is founder, Chairman and Chief Executive Officer, and Mark Dentinger, Chief Financial Officer. Alfred and Mark will make some opening remarks, and then we will take your questions.

With that, I am pleased to introduce and turn the call over to Alfred Chuang. Go ahead, Alfred.

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Alfred Chuang

Thanks, Kevin, and good afternoon. We are very pleased to report second quarter results towards the high-end of the range of expectation that we set on the last earnings call. We continue to see strong SOA momentum in the marketplace and BEA is the only company with a complete SOA platform.

Both our AquaLogic product and also our SOA services continue to lead key deals. We continue to see strength in our core application server business as well, and our AquaLogic products continue to grow.

In Q2, we saw momentum continue in emerging growth areas, such as China and India, as well as improvement in certain key territories, like Germany and the U.S. federal government area.

In addition, license revenue growth continued to fuel operating leverage, as demonstrated by improved non-GAAP operating margin.

Let me first give you some details of our Q2 performance.

Revenue was $340 million, up 19% year over year. License revenue was $136 million, up 15% from a year ago. Services revenue was $204 million, including $161 million of that in maintenance revenue, up 20% from $133 million from a year ago.

Customers that are buying BEA technology in Q2 included CARFAX, Department of Homeland Security, Fannie Mae, HBO-Time Warner, Merrill Lynch, Payless Shoe Source, Pratt & Whitney, and Seagate Technology.

GAAP operating income was $41 million. Non-GAAP operating income was $68 million. Non-GAAP operating income margin was 20.1%, up from 18.3% a year ago.

Cash flow from operations was $50 million, up 22% from $41 million a year ago.

Deferred revenue is up $60 million comparing to last year, now standing at $356 million.

Now let me set the guidance for Q3.

Based on current business conditions, we forecast Q3 total revenue to be in the range of $341 million to $355 million. Later on in this call, Mark will give you more details on our financial performance and also more details on the Q3 guidance.

Now, let me first turn to business. We had strong performances in lots of areas, but we also saw some challenges that we are addressing as we head into Q3.

In Q2, we signed 17 $1 million-plus license revenue deals, compared to only 10 a year ago. The total number of license deals signed in the quarter were 2,419, up by 45 deals compared to last year in Q2.

We have seen sustained growth in our business’ several territories over the last few quarters, particularly our U.S. federal territory and emerging growth areas like China, India and Korea. We are very excited about our opportunities in these emerging areas and are increasing our investment there. We now have more than 450 employees in China alone and we are opening a new facility in Bangalore next week.

Let me make some comments on the market environment. Interest in SOA continued in Q2 and many customers progressed from pilots into production. We saw strong interest in media products overall, however the spending environment in Q2 was choppy in some areas.

In addition in Q2, BEA experienced some isolated performance inconsistencies in some regions and we have already taken action in those regions.

AquaLogic had another excellent quarter and we have executed well on our acquisitions in the AquaLogic product family. In Q2, AquaLogic license revenue represented more than 20% of our total license revenue. AquaLogic products were included in 11 of our 17 $1 million-plus deals.

More importantly, as we grew license revenue from both Plumtree and Fuego compared to the license revenue a year ago when they were an independent company. AquaLogic user interaction customers included Babbock & Wilcox, the Central Bank of Malaysia and Payless Shoe Source. AquaLogic business interaction customers included Broadlane, PG&E and Pratt & Whitney.

On top of that, we grew license revenue from the organic AquaLogic products, which represented a little more than half of our AquaLogic revenue. Customers who bought AquaLogic service starts and data services platform included GE Healthcare and Tufts Associated Health Plans.

WebLogic Server performed well in the quarter as well, but most of the license revenue once again grew year over year faster than industry analysts’ estimates for the market growth. WebLogic Server customers in the quarter included Citigroup, Pfizer and Sirius Satellite Radio.

One of the key industry analysts in our market released new market share data. WebLogic Server was first place in the marketplace for 2005 for total market share. This firm also revised its 2004 market share figures, moving WebLogic Server into first place for 2004 and now 2005, both years.

In Q2, we continued to make progress on our key product initiatives. Our growth strategy for this year focuses on SOA and our WebLogic and AquaLogic product lines. In addition, we are pursuing future growth opportunities like sending application infrastructure into emerging areas.

Let me give you some highlights on our products and services, which are driven by the market trend towards SOA.

Our view of SOA is simple. SOA enables systems transformation and optimization. It solves business problems better than any previous technology approach. The focus should not be on SOA as a technology -- it should be on what SOA can do for the business, the problems that it can solve.

Across the world, in every industry, business is experiencing massive change that places enormous demands on information technology. SOA is a consolidated architecture with a unique power to transform and optimize business to meet those demands.

So why is that? Because SOA is the first architecture that delivers standard-based reuse across every platform, every operating system, every database, every middleware, every type of hardware, and allows organizations to develop, deploy and manage inter-operable business services that can be easily shared as we use inside and also between enterprises.

To put it in terms of that matter, SOA solves business problems. Business users need more speed so they can react quickly to changing marketplace dynamics. They demand faster access to timely, accurate information to support better business decisions. They need to control the business by refusing dependency on IT. That is what SOA delivers.

Our approach to SOA product and methodology reflects our general strategy. We take an aggressive position on the product side and a practical, pragmatic approach to customer implementation. That is why BEA is perfectly positioned to take advantage of the momentum of SOA in the marketplace. BEA is ahead of everybody in helping customers move to SOA with AquaLogic, the industry-leading SOA platform.

So let’s talk about AquaLogic and how it is serving the SOA marketplace. SOA continues to drive a new wave of opportunities to sell products and services and BEA continues our leadership position. This month, VARBusiness magazine awarded BEA as the leader in the product innovation for the web SOA infrastructure category, and also for integration software category.

In Q2, we shipped AquaLogic Service Bus 2.5, including adapters for all of the major ELP packages. The product was awarded the eWEEK Award of Excellence and was identified as an ESB leader in the latest Forrester Wave report.

Gartner also recognized BEA’s position as a BPM leader in their Magic Quadrant Report for BPM suites. BEA is the best executing vendor on this quadrant and the only major platform vendor that is placed in the leader’s quadrant.

Our Services organization also played a key role in expanding our SOA capabilities. In Q2, a consulting organization rolled out two new services offerings to assist customers in addressing the top inhibitors to successful SOA implementation. Our SOA consulting services again successfully drove new customer opportunities and accelerated license deals.

A famous European financial services firm wanted to launch new services to re-enter the competitive independent financial advising market. We began with an SOA consulting engagement, working with the customers on defining its SOA reference architecture and in less than seven weeks, the reference architecture was designed on BEA technology and a $1.5 million license deal was signed. The customer’s first AquaLogic service bus, AquaLogic service registry and a WebLogic portal.

Another example is the Danish Tax Authority, which was required by the new legislation to increase compliance and self-serve capability. BEA worked with our partner, CSB, to beat IBM and we were selected to do a cross-organization, multi-year SOA implementation.

The engagement includes the reference architecture, portal migration and mainframe downsizing. The customer had purchased the WebLogic platform, AquaLogic service bus, AquaLogic service registry and AquaLogic BPM.

Other customers where SOA Discovery Workshops or SOA consulting engagements led to new licenses opportunities or deal accelerations included Circuit City, Nordia, Qantas, Rolex Watch, Swedish Mortgage Bank, SBAB, and the region bank, Sparbanken.

In addition, BEA continues to expand and upgrade our WebLogic product line. In Q2, we shipped a new version of WebLogic Server, Portal and also Workshop. This quarter, Gartner recognized WebLogic Server as a leader in its latest enterprise application server Magic Quadrant.

WebLogic Portal 9.2 shipped this quarter. This major release simplifies the production and management of custom service-oriented portals. Portal 9.2 embraces SOA with support for better based, federated portals as part of its unified portal framework and new community framework simplifies portal management and end-user production for role-based portals. Other new features focus on improved development, deployment and also life cycle management.

A new version of BEA WebLogic Workshop also shipped this quarter. Based on Eclipse, this product just won the JavaPro Reader’s Choice Award for 2006 for the category of Best Visual Bean/Component Development Environment. Customer feedback has been very popular from customers like Prudential, Raytheon and Circuit City.

JRockit is also delivering competitive advantage. Recent performance measurement on Intel’s Woodcrest chip architecture show JRockit is achieving performance results with just two CPUs, rivaling that of four to eight CPUs from a typical competitive environment. We are leveraging performance and manageability technologies in new premium products that will generate additional revenues for BEA.

These are just a few examples of BEA’s product innovations. The bottom line is simple -- WebLogic Server offers the best price performance, period. It offers the best developer efficiency and the best post-deployment manageability of any application server on the market today.

For our customers, that adds up to reduced hardware, development, maintenance, management and total cost of ownership. The WebLogic family serves SOA by providing a powerful and efficient platform for building and exposing custom web services. We believe that WebLogic will continue to be a growth product for BEA for a very long time to come.

Beyond SOA, BEA is also extending application infrastructure into new use cases to build a foundation for future growth, so let me talk about some of it. WebLogic Communication platform continues to receive interest from both carriers and network equipment providers. Our telecommunications technology center in China is very actively working with both the carriers and also the network equipment providers on IMS and also 3G pilot projects. Carriers in this marketplace are looking to expand their revenue through value-added services, which is a very large market to start with, has a lot of deployment and they are developing brand-new voice and data services.

Whilst they are waiting for official award of the 3G licenses in China, carriers are starting IMS program trials and BEA is helping them to lay the foundation. Both WebLogic SIP Server and WebLogic Network Gatekeeper are testing very well in those environments which are all extremely large. And once again, we received some orders for these products, but the market for these products is still in its very early stages.

In our RFID product line, we released the latest version of our WebLogic RFID Edge Server, further enhancing our Edge computing capabilities through support of additional services. We had Q2 wins with a small number of customers in the manufacturing and telco verticals.

Before I turn the call over to Mark, let me summarize. Here is what I see as the key themes of the quarter. First, BEA delivered our fifth consecutive quarter of year-over-year license revenue growth and first consecutive double-digit year-over-year license growth rate.

Second, license revenue growth turned into operating leverage with significantly-improved non-GAAP operating margin.

Third, results are driven by strong organic growth, in particular from both WebLogic Server and AquaLogic supplemented by growth from our key acquisitions.

So now, let me turn the call over to Mark Dentinger, our Chief Financial Officer, for more details on our Q2 performance and also on our Q3 guidance.

Mark Dentinger

Thank you, Alfred. I'll remind everyone that our income statement is prepared under Generally Accepted Accounting Principles, or GAAP, but we also report some income statement measures in non-GAAP format, which excludes certain non-cash and/or non-recurring income and expenses including those mandated by FAS 123 R which we adopted in Q1 of this year.

Most of this discussion references our historical operating performance and forward-looking guidance using our non-GAAP measures. Where GAAP numbers are discussed, I will make the distinction. All balance sheet and cash flow measures are cited or derived from our GAAP statement.

As noted in our press release, our Audit Committee has initiated an investigation into our historical stock option granting practices and the results of this investigation could adversely affect the financial information we have previously reported and/or certain financial information discussed on this call.

Revenue for the quarter was $339.6 million, up 19% year-over-year. License revenue was $136 million or 40% of total revenue, and services revenue was $203.6 million or 60% of total revenue. The largest component of services revenue, customer support, was $160.7 million, a 20% improvement compared to last year's Q2. Consulting and education revenues were $42.9 million in Q2, up 29% from Q2 of last year.

Geographically, the Americas region generated 54% of our Q2 revenue and our international businesses contributed 46% of total revenue. The Americas' contribution was 2 percentage points higher than Q2 of last year. Internationally, our EMEA business contributed 31% of total revenues, a 2 percentage point decline from a year ago and Asia Pacific was 15% of revenues, even with Q2 from a year ago.

Our geographic distribution of revenue was the same as we experienced in Q1 of this year, and a portion of the year-over-year change in distribution is because the predecessor entities of our Business Interaction Division, which were not part of BEA last year, currently generate most of the revenue in the United States.

Q2 total license transaction count of 2,419 was approximately 2% higher than last year, and our average transaction size increased by approximately 13% compared to last year. For Q2, industry vertical performance was as follows: government, 18% of license revenue; telco was 17%; banking and finance, 17%; and services was 15%. Other verticals were individually less than 10% of license revenues for the quarter.

Let me now move on to cost and expenses. Non-GAAP cost of licenses was 5.3% of license revenue for Q2, up slightly from 5% in Q2 of last year. Cost of services was 31.6% of services revenue, which results in a slight margin percentage decline over Q2 of last year. The services margin percentage decline resulted from the comparatively stronger increase in our lower margin professional services business versus our customer support business. A portion of this change is because the Business Interaction Division generates a large portion of its services revenue from professional services.

Total operating expenses for Q2 were $199.8 million or 58.8% of total revenue compared with $174.7 million in Q2 of last year or 61.2% of total revenue. Sales and marketing expense was 35.8% of total revenue in Q2 compared to 37.6% last year. R&D expense was 14.9% of revenue in Q2 compared to 14.6% of revenue in Q2 of last year. G&A expenses at 8.1% of revenue in Q2 were down from 9% of revenue last year.

Our Q2 non-GAAP operating profit was $68.2 million, a $16 million improvement from a year ago. Expressed as a percentage, our Q2 operating margin was 20.1%, up from 18.3% a year ago. Our non-GAAP other income and expense, or OIE, increased to $8.6 million in Q2 versus $1.7 million in Q2 of last year and $3.8 million in Q1 of this year.

The OIE improvement was largely the result of reduced interest expense on our lower convertible debt balances as well as increased yields on our investment portfolio.

Our non-GAAP tax rate was 27% of pre-tax non-GAAP income in Q2 compared to 30% in Q2 of last year. The year-over-year tax rate reduction resulted from a restructuring of our international subsidiaries late in fiscal 2006.

After making the previously-mentioned non-GAAP adjustments, second quarter net income on a non-GAAP basis was $0.14 a share or $56.1 million. Our Q2 results would have been approximately 1% lower in total revenue, 1% lower in cost of revenues and 1% lower in operating expenses if we had translated the current quarter at currency exchange rates in effect last year.

When comparing Q1 to Q1 of this year, our Q2 results would've been approximately 2% lower in total revenue, 2% lower in cost of revenues and 2% lower in operating expenses if we had translated to Q1 rates.

We were also profitable on a GAAP basis during Q2, with GAAP earnings of $0.09 a share, which is the same as Q2 of last year. In Q2 of this year, FAS 123 R added $15 million to our GAAP expenses, which were not in our GAAP numbers last year. Our press release provides a reconciliation and description of the differences between our GAAP and non-GAAP measures.

Our GAAP tax rate for the quarter was 27%, which represents our expected intermediate term GAAP tax rate of 29%, reduced by 2 percentage points for certain Q2 discrete items.

Now, let me address our balance sheet. Our financial position continues to strengthen with cash and short-term investments of $1.4 billion as of July 31, 2006. Cash generated from operations for the second quarter was $50 million or $9 million higher than Q2 of last year. DSO for the quarter was 68 days, two days lower than last year. Deferred revenue increased by about $60 million from last year and now stands at $356 million.

Excluding the previously-mentioned acquisitions, the largest component of our deferred revenue, deferred support, historically has tended to decrease slightly during our first three fiscal quarters and increase significantly in Q4, principally as the result of the timing of some core contract renewals. Changes in deferred license revenue and other deferred services are less predictable, and the balance fluctuates as a function of the timing in terms of transactions.

During Q2, there were no changes to our convertible debt position of $255 million, which is due to be repaid in December of this year. We do not anticipate any additional early retirements unless market values for this debt change substantially before December.

At the end of Q2, we also entered into a new line of credit arrangement, which increased our bank borrowing capacity from about $215 million to $500 million and also reduced the cost of any outstanding borrowings. Upon completing the new arrangement, our net borrowings under the new line of $215 million were the same as under the old one. The new line expires in July 2011.

Let me now move on to headcount. Total headcount increased by 113 during Q2, and we exited the quarter was 4,131 employees. We plan to selectively add headcount during Q3 with an emphasis on our high-growth areas in Asia.

I would now like to make several comments on non-GAAP and GAAP financial guidance. The following comments and guidance are forward-looking statements as are any other comments about our future financial or product performance. You should review our recently-filed Form 10-Q for the quarter ended April 30, 2006, which contains important risk factors that could cause actual results to differ from those contained in these forward-looking statements.

Additionally, product transitions, seasonality factors, uncertain customer buying patterns and concentration of larger deals especially towards the end of our quarter add to our revenue volatility and make it hard to predict revenues in future quarters.

Our comments and guidance are based on current business conditions and information we have as of today's call. We caution investors that numerous factors such as the risk factors discussed above could cause business conditions and customer buying patterns to change significantly. We assume no obligation, however, to update our guidance or comments on future performance. If we do update our comments on guidance, it is BEA's policy to do so through appropriate public disclosure.

Finally, our comments and guidance do not incorporate any estimates for the cost of conducting the stock option investigation, nor do they address any additional cost or expenses which may have to be absorbed in future financial statements resulting from the outcome of the investigation. In determining our guidance, we're not assuming any significant change in the global economic climate or IT spending levels in the near term.

Based on these factors and current business conditions, we anticipate that revenues in the third quarter will be within a range of $341 million to $355 million. We also expect to report non-GAAP operating margins of 20% to 21%, and we expect that the license component of revenue will comprise 38% to 41% of total revenue.

Interest and other income is anticipated to be approximately $8 million to $9 million, and shares outstanding are expected to increase 3 million to 5 million shares from their average Q2 levels before any stock repurchases. We are modeling our non-GAAP Q3 tax rate to 29%. For those of you modeling us on a GAAP basis, we anticipate the differences between our GAAP and non-GAAP earnings will remain significant in future quarters. At the revenue levels we've previously mentioned, our Q3 GAAP operating margins are expected to be 11% to 13% and we are projecting a Q3 GAAP tax rate of 29%.

Thank you for joining us today. And now let me turn it back to Alfred.

Alfred Chuang

Thanks, Mark. BEA delivered a double-digit year-over-year license revenue growth rate for the third consecutive quarter. License revenue growth continued to turn into operating leverage. Our non-GAAP operating margin improved by 1.5 points year-over-year. We are the leader in application server, we are the leader in SOA, and we are expanding our performance lead, delivering innovative new products in growth markets like voice, like services, Voice over IP and most importantly, in the service-oriented architecture space.

We are already seeing significant revenue contribution from these new product lines, and we believe the growth market addressed by these products will be drivers for IT spending over the next several years. Now, I would like to turn the call back over to Kevin and open it up for questions.

Kevin Faulkner

Thanks. So Marvin, we are ready to open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Todd Raker - Deutsche Bank.

Todd Raker - Deutsche Bank

Nice quarter. Two or three housekeeping questions first. First, Mark, on the cash flow statement, there is in operating cash flow and outflow of about $10.7 million, which is defined as other. Could you help us out with that?

Mark Dentinger

I don't know the specific answer to that question, Kevin. I do know that there is a change in GAAP that requires you to classify a portion of your operating cash flow under FAS 123 R, the new stock option standard, as a financing activity as opposed to an operating activity. We had about a $5 million impact from that this quarter, and that component may be included in that $10 million change.

Todd Raker - Deutsche Bank

Then on the stock option investigation, can you guys just comment whether or not you have received any informal inquiries from the SEC or the Attorney General?

Mark Dentinger

We have not.

Todd Raker - Deutsche Bank

Alfred, I think in your commentary you talked about the core business, the web app business continuing to show growth. If I look at the license revenue and I assume AquaLogic has done about 20% of it, that's about $27 million in license revenue. That implies core license revenue of about $109 million, If I look at that on a year-over-year basis, it implies a down growth profile year over year. AquaLogic I don't believe was material Q2 of last year. How do you reconcile that with your comments?

Alfred Chuang

Yes, so I think what happened is typically we have been going out into our Q1 and Q2. We normally see this phenomenon where the WebLogic Server revenue goes up. I think this year, we see a little bit more upside than we have gaining market share. We used to have a categorical platform and an independent product called WebLogic Integration, so the older generation of independent products, those went down.

So if you look at the mix of our product that we saw, the picture really was AquaLogic was up substantially to now claiming about 20% of our total license revenue. WebLogic Server is up, and the other older products like the platform and WLI and some of those other things like the adapters and those things, those went down.

So that pretty much make up to the number of how the other is comprised of and WebLogic Servers should grow.

Todd Raker - Deutsche Bank

Thanks guys, I appreciate it.

Operator

Our next question comes from Katherine Egbert, Jefferies & Co.

Katherine Egbert - Jefferies & Co.

Hi, thank you. It looks like a good quarter. Can you talk about why you are seeing accelerated growth, particularly in billings which is revenue plus change in deferred? Then, you've also got it again to accelerating growth in revenue. What is going on there?

Mark Dentinger

Hi, Katherine. The key thing is that we're getting some thrust in both the license side of the business, which is on par and what we expected, but we are also continuing to see a super strong support business, and it is the support business that is driving a good portion of the thrust in the total revenue. Of course, that is cash rich, which is also helping out the margin picture as well.

Katherine Egbert - Jefferies & Co.

If I missed it, I apologize. Did you say what the communication platform contributed in the quarter?

Alfred Chuang

No, we did not. We did not specifically discuss what it contributed, but we did land several very key deals, Because of the way that we recognize the WebLogic Communications Platform deal, we're new in the network space, so a lot of these recognizable revenues are amortized. So we saw some very healthy deals in the U.S. We have gotten some very significant wins, embedding the technology into several of the network equipment providers in China. We went into trial in a very, very, very big way for 3G and some of the videoconferencing applications on wireless and wireline. Those are extremely successful. So we will see revenue ramping as the revenue becomes recognizable. The momentum of the product is good.

Katherine Egbert - Jefferies & Co.

Then last question, what prompted you to do an internal inquiry or probe into options?

Alfred Chuang

Katherine, it is the fashion of the Valley; I'll be very honest with you. The Audit Committee felt and some of the management felt that it is diligent on our part that we should go to an independent group to look at all this historical stuff. I think it's something that the Board has decided to do. The Audit Committee is running independently. I think we're doing the right thing.

Katherine Egbert - Jefferies & Co.

Thanks, Alfred.

Operator

Our next question comes from John McPeake - Prudential Equity.

John McPeake - Prudential Equity

Thanks guys, good quarter. I just have a couple of questions. First one is on Asia. You gave a total figure there. Could you talk a little bit about specific countries? Maybe throw out some growth numbers -- although, the numbers might be small -- maybe for China year-over-year?

Alfred Chuang

Hi John, good to hear your voice. China grew about 54% year-over-year; they are on fire. We are just executing so solidly in the country. And I think we are just having some unfair advantage in a place which is winning a lot and a lot and a lot of deals. China has now surpassed Japan in size for us. So that's a very extraordinary thing. We're very proud of the team that has done a very good job. We're also invested very heavily. As I said on the call, we have about 450 plus full-time employees. We have more than 100 outstanding requisitions to hire people. So we expect we'll continue to grow the play.

John McPeake - Prudential Equity

Interesting. On your comment on the recognition of the some of the telco stuff, Mark, is it fair to say then you have some deferred license in the deferred revenue account and that contributed some of the increase?

Mark Dentinger

Yes, there's both deferred license and some deferred services component of those engagements. They are big and you've got to dice them up pretty carefully in order to roll them up. But there is some deferred; that's right.

John McPeake - Prudential Equity

We might expect that to continue if you continue to sign deals in that area?

Alfred Chuang

Yes, I think a couple of things may change the dynamics. Right now, because the network side of the telcos are new to using open software, so a lot of these custom projects -- which everything is custom on the network side -- does make revenue recognition a little bit more lengthy.

The thing that would change that picture I think overall will be how the network equipment providers will be selling those product and dragging the licenses through. And that we just started doing and we have done several deals with some major, major NEPs. We expect we probably will get, if not all, most of these NEPs signed up. So I think that's the very exciting news of the time, that would change the way that you see a ramp-up that's much more consistent than right now. We're just barely getting into the game.

John McPeake - Prudential Equity

Thanks a lot, guys.

Operator

Our next question comes from Sarah Friar - Goldman Sachs.

Sarah Friar - Goldman Sachs

Good afternoon and congratulations. Just briefly first on the internal review, do you have a sense of timing for that? Is it something since it's internal and you are running it yourselves that you think you can clean up quickly in a quarter? Or is there a chance it could be ongoing?

Mark Dentinger

It would commence through an internal review, but it is now in the hands of the Audit Committee, who will turn it over to independent legal counsel. We don't have a sense of timing. Obviously, we're hoping for as soon as possible but we do not have a sense for timing.

Sarah Friar - Goldman Sachs

Just to go back a little bit on Katherine's question about the acceleration that you are seeing -- very nice acceleration actually on the bookings line. Alfred, do you feel that that is the environment perking up a little bit as we go into the back half of the year? Or is it just that trends, such as SOA, are over and above anything you see going on on the macro side?

Alfred Chuang

Sarah, I think what happened is we saw other than a couple of spots where our execution was not fully optimal, our execution was very good in the quarter. I think that's one thing that is contributing to the accelerating growth, especially on the license line.

The second thing is the product is hot. And it's been quite some time -- well, for me, it's since the late '90s that we have seen a product picking up this level of pace. So I think SOA has just a lot of inertia in the marketplace, and lots of firms are buying these types of products -- the financial services and the telcos, the manufacturing -- doing well-integrated projects.

That's what the customer is spending money on, including your firm for example. So I think that's very exciting to see. I think that's a very key driver in getting us back in growth again. I think we're very focused. I think we're very careful in our spending. I think we have a lot of inertia in the Company.

Sarah Friar - Goldman Sachs

Great. Then just a final one on the cash balance, which is building quite nicely. Mark, I think you made the point that you don't want to go in and buyback the debt ahead of time at this point. Does that mean that we might see you use some of the cash for stock repurchase at this stage? Or is it holding on to it for maybe acquisitions?

Mark Dentinger

It is possible. We have some internal parameters under which we would get into the market for stock repurchases, and we still have about $123 million remaining on the Board authorizations to repurchase stock. But we don't have definitive plans yet. We just have contingent scenarios under what we might do under certain circumstances.

Sarah Friar - Goldman Sachs

And on the acquisition side, would you consider more acquisitions now that you are getting Plumtree and Fuego fairly well integrated?

Alfred Chuang

Sarah, we're always in the mode of buying stuff. I think it's opportunistic. It's also strategic. We have our targets in mind. We have several areas that we're still filling some void in our product line, especially with people that were looking for more expertise. So it's very likely that you will see more acquisitions but probably not likely that you will see a big acquisition from BEA in the short-term.

Sarah Friar - Goldman Sachs

That’s very helpful. Thank you.

Operator

Our next question comes from John Walsh - Citigroup.

John Walsh - Citigroup

Alfred, could you give a little more color on the Fuego product in particular, just the traction and the demand environment for that product as you got a full quarter under your belt now?

Alfred Chuang

Sure. It's still new. BPM is a very hot marketplace. This product is hotter than hot, and it blew away our internal goal in the quarter. It is something that clearly everyone is out there doing, which is business transformation and business optimization. BPM is the very key thing for leading people into buying our Service Bus technology also. We saw a fair amount of independent sale of the Service Bus, but also the BPM technology is just driving a lot of the Bus sales.

So I think that is very exciting for BEA. We are getting into an area of technology implementation in our customers' space that we have never been in before. So my expectation is that growth will continue on going into Q3 and the rest of the year.

John Walsh - Citigroup

Just any more color you can give on the locales that you had said a little bit uneven execution and the changes that you made? Were they significant or were there people changes or just organization kind of structure go-to-market changes?

Alfred Chuang

Yes, we saw one particular spot in the Americas that was quite weak. We made some personnel change at the management level, and then we saw a one particular weakness that we've seen in one other country in Europe. We actually had let the person go, and we have made a more significant management change there. So we actually made those moves pretty swiftly as soon as the quarter was over.

John Walsh - Citigroup

Great, thanks a lot. Good quarter.

Alfred Chuang

Thank you.

Kevin Faulkner

Martin, any other questions?

Operator

Our next question comes from Robert Breza - RBC Capital Markets.

Robert Breza - RBC Capital Markets

Hi, congratulations on a nice quarter. Questions both for Mark and Alfred. You talked about entering Bangalore. Mark, can you talk to us a little bit about what we could expect in terms of operating leverage as you enter that country?

Alfred, what kind of services do you intend to kind of outsource or how do you plan to use that operationally to either move more of the tradition stuff over there? How should we think about your entry there? Thanks.

Mark Dentinger

Yes, on the operating leverage, we're getting the same leverage that many of the other companies that have gone into India are getting in Southern India. Right now, as you know, developers and support personnel, people like that, we can hire there probably for one-third on the dollar than we can here.

It's an unstable market, so people do move around. We been very fortunate we been able to hold on to the core teams that we've been assembling there. But between there and China, we do get a substantial cost advantage, and those are two targeted high-growth areas for the business. So we hope to be able to continue to harvest increased leverage out of those areas.

Alfred Chuang

To answer the question, there are several things that we're doing particularly in India. One is part of our call center is outsourced to our own employees and also to PCS and Infosys that's based in India. We also have developed a fairly substantial-sized development organization that are our own people.

The primary work that they are doing has to do with regression testing, documentation and final assembly of some of our software. I think we have done very well. Our attrition rate is fairly low compared to the marketplace. We just put everybody in a new facility that will be opening up formally next week, and we will continue to see substantial growth. The leverage is between 1:5 to 1: 8 in terms of ratio of costs. So it's still a very attractive place to do business in terms of developing and supporting our customer.

Operator

Our next question comes from Peter Cooper - Morgan Stanley.

Peter Cooper - Morgan Stanley

Great, thanks. I have a general question, guys. There's been a lot of chatter about telco spending, obviously a topic near and dear to this conversation. You said a little bit about the environment out there. Can you give us more of a granular look at telco spending and plans? Obviously, competition for these guys of adding services is not going to abate. At SOA, I know you have some good wins already, but are you seeing any momentum there where we might see some larger deals towards the end of the year or maybe into '07?

Alfred Chuang

Yes, I think we will. I think all the focus in the large telcos are all in the triple-play area, which is voice and data, IPTV and wireless. Those four things are combining into one, and we are seeing more and more. I think it started with a trend in Europe, and now it's overflowing into the Americas also, everyone is going to the triple play. It plays right into our hand where there is a lot of complex integration that's involved.

We're also seeing that we've done some deals with some cable companies in this past quarter that they are getting into the data space very successfully. So I think it's a different landscape that's going on this time around. It's not deregulation; it's actually consolidation in the telco space. It's heading towards buying from one single place, multiple type of services and you have exactly the same service, whether it's music playing at home or on your phone or any location you happen to be. Those are the kind of things that people are buying into.

One of our very, very large telco customers in the East Coast is putting 100-megabit network directly into the house onto the wall. At the same time, they are providing a set-top box and providing basically the portal into the home. So those kind of plays require our technology. We are the biggest and the most familiar vendor. The CIOs and the CTOs in these firms are becoming one person. Almost every single one is going to that direction, so we do have a bit of an advantage in moving into the network side and helping them get the stuff for triple-play technology implemented.

It does mean, I think towards the end of the year, we could see more larger deals because the consolidation of some of these deals into one or some of these accounts becoming one single customer. Obviously, you know like the AT&T, they become one single customer for us with many different points, so we should see more uptick in that area.

Peter Cooper - Morgan Stanley

On that thought, there's been a little bit of noise about kind of let's say the endpoint. You mentioned into the home , the living room I guess the endpoint there. I think with BT and some other folks, BT has been a good customer of yours in the past. But as people move to the endpoint, is there a lower end product opportunity there? Is that something you may want to try to fill in a gap as to bolster the strength at that lower end of the market, the endpoint if you will?

Alfred Chuang

I think we're doing a few things. Some of our customers are doing very low-end type technology going straight into the set-top box or portals, and I think we will continue to see more of that. As we see in the past, they have experimented with PC-based technology and had not seen huge success as the reliability has not been the highest; the television viewer and PC users are quite different in the context of the tolerance for error and reboot and control-alt-delete are low. I think we are helping in a big way in that area.

A huge deployment we're not seeing yet because I think a lot of these things are still barely in the trial stage with set-top box going into the home. We may actually see some more of these stuff being rapidly implemented in Asia and stuff because they have nothing. So the first time that they will have a broadband go into their home will be through one of these set-top boxes. Then we're distributing out to have data, voice and also TV at the same time.

So I think it's an exciting time. We will see more of that now. We will probably at some point in time repackage and embed solutions for those kind of deployments that will be no touch. Any upgrade will be directly going through the network itself where you have such a product in place ready to go, so we do expect that to happen at some point.

Peter Cooper - Morgan Stanley

Thanks very much.

Kevin Faulkner

Operator, we have time for one more question.

Operator

[Technical difficulty – audio cut]

Kevin Faulkner

Terry?

Terry -

Alfred, I had a question in terms of AquaLogic. How should we think about this as an opportunity within traditionally non-BEA WebLogic accounts, whether it is IBM focus shops or Oracle shops? Are you seeing any traction in non-traditional WebLogic shops?

Alfred Chuang

We have an organization headed by Mark Cargess for the business interaction division. So it is a separately-run organization that has sales, services, G&A that's stays in this location. So Mark's organization sells into both traditional BEA space and the non-BEA installed base. More than 50% of the sales that's accounted to non-BEA-based technologies like WebSphere a lot of .NET so Oracle and other people's technology. So that's going really well. I think we're seeing a lot of traction and selling of business interaction, our portal technology, BPM in the non-BEA traditional accounts.

Terry -

Alfred, you talked about how just the WebLogic Server business did grow year-over-year. I guess one can't look at the $118 million last year in license revenue and assume that's just the server business because I guess there is Tuxedo, there's WLI and there's other things.

I was just wanting to focus more on your comment that you grew faster than the industry in the second quarter. What was the industry growth rate in the second quarter for traditional middleware?

Alfred Chuang

I think the general estimates for the application server space that the analysts are estimating was somewhere between minus 3% to plus 3%. So we clearly have more than 3% in the way that we have calculated our license revenue growth effort. So we're confident that we've grown must much faster than the marketplace has grown for the traditional application server space.

On the AquaLogic side, I think there's no comparison. We now have 20% of our sales with AquaLogic. I don't think anybody is selling platforms or SOA like we do.

Terry -

Just a final question relates to the guidance looks strong. But in the sense of if I calculate the license guidance, it is a broader range than we've seen more recently. Is there something to be said that there's some larger deal exposure in the third quarter that we should be looking at? Is that a sign of that?

Alfred Chuang

I think we're just trying to be always as a good citizen to be conservative in our guidance. I think we have made a couple of changes in two, I would say pretty key, areas from a geographical perspective. There's always risk in doing that. But I think if you look at our guidance, I think it's a healthy guidance we've given.

Terry -

Yes, I agree. Nice job on the quarter, guys.

Alfred Chuang

Thank you very much. Again, this wraps up our call. I want to thank everyone who has listened to the BEA Q2 earnings call for fiscal year '07. I look forward to seeing all of you at BEA World both in San Francisco in this quarter and also in Prague for Europe. I'm looking forward to speaking to you in our earnings call after Q3. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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Source: BEA Systems Q2 2007 Earnings Conference Call Transcript (BEAS)
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