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Business Objects (BOBJ)

Q3 2006 Earnings Call

October 25, 2006 5:00 pm ET

Executives:

John Ederer, Vice President, Investor Relations

John Schwarz, Chief Executive Officer

Jim Tolonen, CFO, Senior VP Finance and Administration

Analysts:

Thomas Ernst, Deutsche Bank

Michael Breve, UBS

Mark Murphy, First Albany

Mohammed Moawalla, Goldman Sachs

Daniel Cummins, Banc of America Securities

Christopher Sailer, Goldman Sachs

Nabil Elsheshai, Pacific Crest Securities

David Wright, BMO Capital

Frank Sparacino, First Analysis

Mike Abramsky, RBC Capital

Tom Roderick, Thomas Partners

Peter Goldmacher, Cowen & Co

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 Business Objects Third Quarter Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question and answer session. If you would like to ask a question during this time simply press * then the number 1 on your telephone keypad. If you would like to withdraw your question press * then the number 2. Thank you. Mr. John Ederer, you may begin your conference.

John Ederer, Vice President, Investor Relations

Thank you and welcome to the conference call to discuss our financial results for the third quarter of fiscal 2006. This call may not be reproduced in full or in part without the written permission of the company. The webcast of today’s call will include a set of slides that accompany the speakers’ comments. The press release and the slides will also be available on the Investor Relations section of our website. Joining me on the call today are Business Objects’ Chief Executive Officer John Schwarz and Chief Financial Officer Jim Tolonen.

During the course of today’s call our executives will make forward-looking statements including statements regarding product acceptance, strategic and operational plans, the company’s expectations of the business outlook, future financial and operating results and in particular with regard to the fourth quarter and full year. We wish to caution you that such statements are just predictions based on management’s current expectations or beliefs and that actual events or results may differ materially. We refer you the documents we filed with the Securities and Exchange Commission including Form 10-K for the year ended December 31, 2005, and Form 10-Q for the quarter ended June 30, 2006. These documents identify important risk factors that could cause actual results to differ materially from those contained in our forward-looking statements. These potential risks and uncertainties include but are not limited to fluctuations in our quarterly and yearly operating results, our ability to sustain or increase our profitability, our ability to attract and retain customers including for Business Objects XI, our ability to successfully integrate the companies we acquire, changes to our current accounting policies, our ability to preserve our key strategic relationships and are reliant upon selling products only in the business intelligence markets. We assume no duty to confirm, update or revise the financial forecast for the year or any other forward-looking information in this call as the result of new developments or otherwise.

Today, we will be discussing our results on a U.S. GAAP as well as a non-GAAP basis. These non-GAAP results also sometimes called pro-forma results exclude write off of in-process research and development charges, amortization of purchase intangibles, and stock-based compensation expense. We use these additional non-GAAP measures as we believe they give useful operating information in addition to the U.S. GAAP results. A reconciliation of U.S. GAAP to non-GAAP financial statements is available in our press release and on our Investor Relations web page. I will now turn the call over to Jim Tolonen to review our financial results for the quarter. Jim.

Jim Tolonen, CFO, Senior VP Finance and Administration

Thank you John and thanks to all of you joining us on this call. Overall, we were very pleased with our results this quarter as both revenue and earnings per share exceeded the top end of our guidance. Furthermore, we continue to make progress on our operating margin goals that we set out to achieve more than a year ago. Some of the key highlights in this quarter were that we continue to produce double digit total revenue growth, which we have done now for every quarter in 2005 and 2006. We achieved solid license revenue growth and continued our strength in maintenance and services revenues growth.

Revenues grew in each of our three primary geographies and large deals were up from the prior quarter with six transactions greater than $1 million in the Americas, two in Europe, and one in APJ for a total of nine transactions over $1 million in license revenue including one of the largest ever single transactions in EMEA.

In terms of the specific revenue results for the quarter, our total revenues were $310 million, up 19% year-over-year and above the top end of our guidance of $293 million to $298 million by $12 million or 4%. On a constant currency basis our total revenues were up 16% year-over-year.

License revenues were $132 million, up 9% year-over-year and 7% on a constant currency basis. Services revenues including maintenance and global services were $179 million, up 27% year-over-year, 24% on a constant currency basis.

Net income on U.S. GAAP basis was $20 million or $0.21 per share. Our guidance for these U.S. GAAP earnings per share was $0.15 to $0.18. This net income was flat year-over-year; however, included approximately $11 million of additional stock-based compensation expense under FAS 123R in the current quarter and compared with the prior year quarter. Non-GAAP net income was $39 million or $0.41 per share, up 37% year-over-year and 17% above the high end of our guidance range for non-GAAP earnings per share, which was $0.32 to $0.35.

Taking a closer look at revenue for the third quarter, the total license revenue of $132 million is reported in three product families -- Core BI, Enterprise Performance Management, and Enterprise Information Management. License revenues for core BI came in at $100 million representing a decrease of 5% from the third quarter of last year, although a sequential improvement of 4% from the second quarter of this year. The sequential improvement is due to the continued traction of Business Objects XI and more specifically Business Objects XI Release 2. Of course this overall growth rate continues to be impacted by customer focus on migrations and the decline in sales from the older versions of our pre-merger products.

License revenues for enterprise performance management applications were $19 million for the third quarter representing growth of 138% from last year. This growth is partially driven by the growth of SRC within our product suite and also by growth of the dashboard and product management solutions.

License revenues for enterprise information management applications were $13 million for the third quarter representing growth of 74% from last year. This growth was driven both by the addition of Firstlogic in the current year results and also by the strength of our data integration products. Included in the above categories, Business Objects XI revenues grew to $96 million, up 47% from last year with XI Release 2 growing 34% sequentially and accounting for over 82% of the total XI revenue in the current quarter.

Maintenance revenues for the third quarter came in at $129 million, up 24% from last year and the strength of new license sales, very strong maintenance renewal rates, and the inclusion of maintenance from Firstlogic which was not in the year ago quarter.

Global services revenues grew to $50 million in the third quarter, up 34% from last year. As our professional services organization continues to improve utilization and margin while gaining traction in the market place as our customers seek broader enterprise wide business intelligence implementations.

Turning to the expenses, cost of revenues were $78 million on a U.S. GAAP basis resulting in gross margin of 75%. On a non-GAAP basis cost of revenues were $67 million resulting in a gross margin of 78%. The U.S. GAAP gross margins are down slightly year-over-year primarily due to the inclusion of FAS 123R stock-based compensation expense in 2006. Sales and marketing, research and development, general and administrative expenses were all generally in line with expectations for the quarter.

Income from operations was $29 million on a U.S. GAAP basis representing an operating margin of 10%. As you know, all of the 2006 U.S. GAAP expense numbers include stock-based compensation expenses now required under FAS 123R, and in total $13 million of stock-based compensation expense was recorded in this third quarter versus only $2 million in the year ago quarter. Also included in the U.S. GAAP numbers are approximately $11 million of amortization of intangible assets compared with $10 million in the year ago quarter.

On a non-GAAP basis then, income from operations was $53 million, up 29% from the prior year and now representing an operating margin of 17% in this quarter. Our non-GAAP operating margin improved almost 4 percentage points sequentially and 1 percentage point year-over-year.

We continue to make progress towards our mid-term operating margin targets that we laid out for you last fall as we continue to focus on operational excellence initiatives that span the entire company.

At the end of the quarter, total employee head count was 5141, up approximately 3% from the prior quarter. This increase was primarily due to acquiring the operations and employees of our previously outsourced India development center, partially offset by decreases in most other areas of the organization due to a deliberate slow down of our replacement hiring this quarter.

Our balance sheet continued to strengthen in the quarter, driven by strong cash flow from operations. Total cash, cash equivalents, and investments grew to $504 million, up $29 million from the end of the second quarter. This brings our year-to-date growth in cash to $167 million after using $65 million for acquisitions.

Total deferred and long-term deferred revenues were $262 million at September 30, 2006, up $53 million from December 2005 and $66 million from the prior year quarter. Day sales were great remaining flat at 73 days this quarter, right in the middle of our guidance range.

Moving now to forward guidance, the following information regarding our forecast for the fourth quarter of 2006 and full year 2006 represents our outlook only as of the date hereof and we undertake no obligation to update or revise this forecast or any other forward-looking statements herein as a result of new development, and today we are providing guidance both on a U.S. GAAP and on a non-GAAP basis.

Total revenues and earnings for the fourth quarter are expected to be up sequentially due to both the seasonally strong fourth quarter and the ALG Software acquisition. Our guidance for the fourth quarter of 2006 consists of total revenue of $348 million to $356 million with a U.S. GAAP diluted earnings per share of $0.29 to $0.34 per share and non-GAAP diluted earnings of $0.53 to $0.58 per share. The non-GAAP guidance for the fourth quarter excludes approximately $12 million of stock-based compensation expense, $12 million of amortization of intangible assets, and $3 million write-off of in-process R&D in the ALG acquisition adding back approximately $0.24 per share after tax. This fourth quarter guidance includes approximately $5 million of revenue from the ALG Software acquisition with $5 million loss on a U.S. GAAP basis and $1 million loss on a non-GAAP basis.

For the full year, we have increased both our revenue and our non-GAAP earnings per share guidance from the previous guidance in light of the strength in the third quarter and the ALG acquisition closing in the fourth quarter. We have decreased our U.S. GAAP earnings per share guidance primarily due to purchase accounting expenses of the ALG Software acquisition and the slight increase in our estimated U.S. GAAP tax rate.

Our guidance for the full year of 2006 consists of total revenue of $1.231 billion to $1.239 billion, U.S. GAAP diluted earnings of $0.71 to $0.76 per share, and non-GAAP diluted earnings of $1.57 to $1.62 per share. The non-GAAP guidance for the full year excludes approximately $44 million for stock-based compensation expense, $48 million for the amortization of intangible assets and write-off of in-process R&D, and these add back approximately $0.86 per share after tax.

The U.S. GAAP guidance assumes an effective tax rate of 43% for the fourth quarter and 44% for the full year of 2006. The non-GAAP guidance assumes an effective tax rate of 33% for the fourth quarter and 32% for the full year of 2006. And finally this guidance is based on a U.S. Dollar to Euro exchange rate of $1.26 per Euro and U.S. Dollar to Canadian Dollar exchange rate of US$0.89 per Canadian Dollar. Fully diluted shares outstanding are expected to be $96.2 million for the fourth quarter and $95.5 million for the full year of 2006.

To summarize our financials this quarter, we had a very good quarter delivering license, maintenance, and services growth with particular strength in the Americas and a strong return to the growth for the APJ region. We had nine license transactions over $1 million. Business Objects XI continued to gain traction, was up 47% year-over-year to $96 million. All of our acquisitions completed over the past year are performing well and we continue to benefit from productivity improvements and are making progress towards the margin goals we set last year. And finally the balance sheet remains strong with cash and deferred revenue growth.

Before I hand the call over, I’d like to remind you that we will be hosting our annual analyst day in San Francisco on November 6th during the company’s Inside Americas event, and we hope to see many of you there. With that I’ll turn the call over to John Schwarz to provide some additional detail on the quarter and our strategies. John.

John Schwarz, Chief Executive Officer

Thank you Jim. Let me add my thanks to all of you for joining us on the call today. Jim has already walked you through the highlights of our financial results, but beyond our financial performance I am pleased with the results of the operational improvements that we’ve achieved as a team in the past 90 days. Today, we can report our execution is stronger in the key focus areas; as for example, we signed most of the opportunities that slipped from us last quarter and had nine deals greater than $1 million in the third quarter, a level which is on par with our historical achievements.

The Americas team continues to execute extremely well in all areas of the business. EMEA returned to positive year-over-year revenue growth and revenue was up sequentially in what is typically a difficult quarter, the third quarter of the year. In APJ our team is starting to execute very well after achieving sequential revenue growth last year, the division has contributed in a much more satisfactory way in the past three months with 19% year-over-year revenue growth. Finally, in terms of migrations to Business Objects XI the programs we put in place at the second quarter are beginning to have an impact.

Taking a closer look at our geographic performance this quarter, Americas led the way again with yet another strong performance. Total revenue of $175 million for the third quarter was up 27% from last year. This growth did include the benefit of recent acquisitions, most notably Firstlogic, but was also driven by strong organic growth.

During the quarter the west region and the public sector had one of the best performances we have ever recorded. The strength in the Americas region over the past several quarters has been driven by solid and balanced execution in both the enterprise accounts, and in the mid-market. In addition, this region has had more success with acquired solutions as many of our recently acquired companies have brought us a very solid customer base, specifically in North America.

During the quarter we signed deals with Banner Health, BMC, The Defense Logistics Agency, The U.S. Navy, The U.S. Social Security, and Zions Bancorporation just to name a few. Another customer in particular I’d like to highlight was Kaiser Permanente, the largest provider of integrated healthcare in the United States. Kaiser is standardizing on Business Objects XI and will be using our products for core BI and enterprise information management in multiple areas of their business.

Perhaps the most satisfying feature of our North American business is that many of the large transactions are taking shape of complete solutions with a comprehensive offering comprised of EIM, core BI, and EPM as well as related services, with EPM or EIM often providing the initial opening for the customer relationship. For example, Johnson Controls has selected Business Objects as their preferred partner for business intelligence projects around the world. The Business Objects solutions will initially be installed alongside the SAP, PeopleSoft, and Pay-Zee payroll systems at the Johnson Controls. Our primary goal of the new partnership was enterprise standardization. We addressed this requirement with our new safe passage program which provides migrational systems, conversion utilities, and education to readily migrate and micro-strategy environments to our jointly defined standard product offerings.

EMEA returned to growth this quarter with total revenue of $130 million, up 7% from last year. While there is still room for improvement for our performance in EMEA, the recovery programs we put in place last quarter are having a positive effect. In particular, we talked about offering new customer programs to accelerate migration plans, adding targeted marketing programs to increase demand in the mid-market, and establishing a global team to focus exclusively on Business Objects XI migrations. As we indicated last quarter, these initiatives will take some time to have a measurable impact, but we believe that we are on the right track. This is evidenced by higher closing rates in the third quarter in EMEA. We’re seeing improvements in the migration process as a result of better planning, better organization, and dedicated technical and service resources.

As we accelerated ramp in XI, revenues suggest customer are migrating to the new platform and we are building reference accounts that will help us in the future. We’re also gaining traction in the middle market with our OEM partners.

A key customer win for us in EMEA this quarter was the French Ministry of Agriculture and Fisheries, which is migrating to Business Objects XI Release 2 and extending its base of users. This is a standardization project that will include financial performance management as well as obligations to track livestock and reduce animal health and sanitary risks. This customer is a great example of a company that is moving simultaneously to the XI platform while also adding new users and applications.

Asia-Pacific and Japan had a breakthrough quarter and returned to positive year-over-year growth posting total revenue of $23 million, up 19% from last year. Over the past several quarters we have built a new team in APJ and they are starting to produce results which are more in line with our global expectations. In fact, the third quarter revenue for the APJ division was the highest it had ever been. A key new customer this quarter in APJ was Keobo Life Insurance in Korea, where Hibernian Solutions was the incumbent vendor. Keobo Life will use Business Objects XI Release 2 to reduce dependence on the IT department for business information. It will give over 500 users from different departments the ability to access data when and where they need it to make strategic business decisions.

APJ also closed a large transaction with the Australia Post that will provide an organization wide standard Business Objects and performance management platform to optimize the handling of the many billions of pieces of mail delivered to Australian homes and businesses.

Over the last year, we’ve talked to your about our key growth initiatives. These included further investment in expanding our portfolio in key product areas, global services growth, continuing expansion into the mid-market, and the investment in Asia-Pacific Japan. As a result of these investments we’ve been able to produce consistent double digit total revenue growth. Looking specifically at these initiatives in the third quarter, core business intelligence total license revenue was up sequentially from the second quarter. Underneath the core BI growth is the continued and growing strength in the Business Objects XI platform, which now represents over 80% of the total core BI license revenue and is effectively replacing the sales of older versions. This should be further accelerated as version 5 of the old Business Objects platform goes to maintenance end of life at the end of this year.

The product team is delivering frequent drops of new code with quality, performance, usability, and functional enhancements, we’ll make new key product announcements and directional statements at the Americas Inside Customer Conference in early November in San Francisco.

Our enterprise performance management solution that includes planning, budgeting, and dashboard components are continuing to demonstrate solid growth this quarter, up 138% year-over-year and 19% sequentially. Just after the close of the quarter we announced that we have completed the acquisition of ALG Software, a leading providing of EPM solutions for profitability management, activity based casting, and predicted planning. ALG Software is based in the U.K. and in addition to providing complimentary technology to our EPM suite of products it will also give us a broader geographical base for our EPM solutions. The combined SRC, ALG, and Business Objects development teams are building a common infrastructure and services platform for these applications that will share the features and the value of the XI base.

Enterprise information management, which includes information integration and data quality grew 74% this quarter. Our growth in EIM has been boosted by the recent acquisition of Firstlogic, which we have been able to integrate very quickly. EIM is a fast growing segment of the BI market and we now believe that with Firstlogic we have the most competitive solution in this area. We consider the EIM solution to be the most effective vehicle to help customers to integrate their disparate applications by combining data into trusted, cleansed, and linked structures, we provide the environment on which new information-centric applications can be developed.

The growth of our global services organization continued at a rapid pace this quarter and was up 34% year-over-year. Driven by customer demand for single vendor solutions that address their BI needs. Margins for services offering are also continuing to improve due to increased billing rates and better utilization of the available resources. Both consulting and training services have become a key component of ensuring customer satisfaction with their BI deployments. We share our services IP and collaborate with our partners in both the sales and the deployment phases of BI projects. Today, some 80% of the services content associated with our solutions is delivered by our partners.

Finally, the mid-market is another rapidly growing opportunity in BI and a natural extension for us with our broad suite of solutions and our extensive indirect distribution channel. This quarter we organized ourselves to bring additional focus and resources to this important mid-market area. Over the upcoming six months we expect to bring to market new targeted products, simply business terms, new partner programs and campaigns, and expanded software as a service offering.

A key element of our strategy in the mid-market is the leverage that we gain from our 3000-partner strong indirect channel OEM and global alliances. During the third quarter our indirect channel accounted for 48% of our license revenues. The OEM business grew with 21 new partners and we also added over 100 new VARs this quarter. We are rolling out our global partner framework for the first time in Asia which will provide additional channels of growth in this region for the future.

So to summarize, I am very pleased with our performance this quarter and I believe that we have made significant operational improvements over the last 90 days. From a geographic standpoint Americas is continuing its strong growth, EMEA has taken a step in the right direction, and the turn around of APJ has become evident. We also continue to make good progress on all of our growth initiatives including core BI, EPM, EIM, global services, and the mid-market, and this broad approach to the market is enabling us to produce consistent double digit topline growth.

Finally, we are leveraging our revenue growth with continued margin expansion. I believe our results this quarter demonstrate our commitments to improving profitability and that we continue make progress towards the targets that we laid out for you last fall.

We are confident in our business performance outlook and are continuing to invest for growth and better bottom line results. I’d also like to take this opportunity to thank the entire Business Objects team for staying the course, for digging in and delivering very solid results in the third quarter.

Thank you for joining us this quarter and I’ll now turn the call back to the operator to open up the lines for your questions.

Question-and-Answer Session

Operator

At this time, I would like to remind everyone if you would like to ask a question please press * then the number 1 on your telephone keypad. We’ll pause for just a moment to compile the Q&A roster. And our first question comes from the line of Thomas Ernst with Deutsche Bank.

Thomas Ernst, Deutsche Bank

Good afternoon gentlemen, thank you. I guess what stands out even more striking to me than the strong third quarter is the bullish outlook for the fourth quarter, and as I look at the second half the comparables last year weren’t easy, so this is very strong growth. The question is what gives you the confidence that we don’t have, kind of the disappointment you saw last quarter, I mean how do you know that now you’re on track to start delivering these kinds of solid growth targets?

John Schwarz, Chief Executive Officer

Well I’ll ask Jim to pipe in as he sees from his perspective, but I think we’ve pretty much said it in the remarks that we’ve made thus far. If you look at our geographies they are all turning in a much more confident and much more solid set of results. If you look at our closing rates of the deals that we closed from the pipeline currently on hand, we have improved in the third quarter over what we saw in the second quarter and the first quarter. We are seeing deals that seem to have been difficult to close in the second quarter, actually closing with undiminished revenue from the expectations. So, at the end of the day, I think that the basic business indicators are solid enough to have given us the confidence to have delivered to the kind of guidance that we did. I would say that the guidance is confident but not overconfident based on historical data that we see in our business.

Thomas Ernst, Deutsche Bank

Great, a quick followup if you’ll permit to that. For the first time I’m wondering what the end of life on version 5 is, I know there’s still a significant version 5 install base, how much of revenue do you think helps to license revenue generation here already in the fourth quarter? And then the second part, with the widespread kind of press and street rumors about an Oracle bid for Business Objects, I’m wondering if you saw that translate into any deal impact, if you heard your sales people complaining about customers don’t wanting to do business with you because you might be bought?

John Schwarz, Chief Executive Officer

Actually no, customers or at least our sales people frankly have their own experience and have fun with the rumors talking to customers. It’s a good door opener, it’s a good way to break the ice when they’re making a senior call, because at the end of the day all we can do is talk laugh about it. We do not see the rumors impacting our sales. As far as the sales performance or the sales confidence that led us to results that we have just reported and to the guidance that we have given, we are seeing our sales team getting to be more confident, more experienced, more capable of dealing with the competitive objections, more confident that the solution that we delivered, the XI solution, is truly a dramatic improvement over version 5 and 6, and if you look at the breakdown of sales of XI versus the older versions of XI now representing more than 80% of all the core BI license sales, numbers would speak for themselves.

Jim Tolonen, CFO, Senior VP Finance and Administration

Tom, I might add just a couple of things on the earlier question too with regard to guidance. I think we’ve said three things that are resolved. One was the good third quarter and the closure of some of the deals that have slipped, in fact just a better large transaction closing rate this quarter approximately equal to the year ago quarter, nine deals over $1 million this quarter, 10 a year ago, so that was encouraging. Second for me I think also very encouraging was the strong post-acquisition growth in our acquired companies in the last year at almost 100% growth in Xcelsius, again small numbers but very good pickup and uptake in the integrated company, more than 148% growth in the EPM area, much of that from the SRC acquisition which is now a year old, but certainly has growth post acquisition from their earlier run rates, and now Firstlogic integrating so smoothly. I think all of that is good confidence as well, and of course the fourth quarter is our seasonally strongest one.

Thomas Ernst, Deutsche Bank

Great, thank you again.

Operator

Our next question comes from the line of Michael Breve with UBS.

Michael Breve, UBS

Good evening, thank you. Could you talk to us a little bit about the acquisition contribution specifically on Firstlogic and SRC, how much license did they contribute in the third quarter and how much revenue did they contribute?

Jim Tolonen, CFO, Senior VP Finance and Administration

I’ll pull that up in a second, but in general we are no longer commenting after a year in on the SRC acquisition, to say it’s integrated into our total and overall but it still a significant portion of the EPM revenue for us, and as I mentioned it is up well over 100% year-over-year from its earlier run rates. With regard to Firstlogic, I have someone pulling it up here for me as we speak. Let’s go on to the next question.

Michael Breve, UBS

If I may follow up then, I think if we look at the core BI business, it was still down around 5% year-on-year. You said in the second quarter that the U.S. or Americas business was up, which suggested that Europe was very weak in core BI, can you give us an idea on what’s happening in Europe on the core BI side?

John Schwarz, Chief Executive Officer

As we had reported on the last quarter’s result, the EMEA experience with the Business Objects XI platform is roughly a year more recent than the experience that we have gained in the Americas, and we are still going through the early growth curve of the adoption of that platform in Europe, and so the degree of attrition if you will of the older versions have not yet been displaced by the growth in XI. In the Americas we’ve only crossed that curve, but in EMEA the crossing point is still in front of us. But the slope on which EMEA is adopting XI mirrors pretty well with the slope that we are seeing in the Americas, so a big confidence that we are just a quarter or two away from seeing the same kind of results over there.

Jim Tolonen, CFO, Senior VP Finance and Administration

I’ve got the answer Michael for you on that other one – about $12 million of contribution in the current quarter from Firstlogic, a little less than half of that, maybe $5 million from license, and again we have a declining loss of the deferred revenue down to probably less than $2 million to go, maybe $1 million in the quarter and the next quarter $1 million. We’re almost back up to full strength there in terms of the purchase accounting as well.

Michael Breve, UBS

Thanks, I’ll maybe ask John that in terms of the XI sales how much of that would be Americas and how much would be Europe?

John Schwarz, Chief Executive Officer

While Jim is looking let me make another comment on the European performance which is that another advantage the Americas have had, not that I want to take away anything from the Americas performance which was really superb, but the advantage that they’ve had is that the acquired companies over the last 12-18 months have been largely based in the U.S. and have been rather small, therefore having very little footprint in Europe. So, as we add these acquisitions to our portfolio we have to build the EMEA capacity from scratch, and as you might imagine that takes a little bit of time. Again, I’m very pleased with the progress that the European team has made with the adoption of EPM which is moving along very well, the adoption of EIM which is moving along very well, and we just need the time to build out the same base of customers and capacity that the Americas have had.

Jim Tolonen, CFO, Senior VP Finance and Administration

I’ve go the answer to that question and interestingly perhaps but it’s of the total XI revenue about 53% from the Americas, 36% from EMEA, 11% from APJ which you might say is almost exactly similar to the total revenue mix, taking good traction in all geographies.

Michael Breve, UBS>

Okay, thank you very much.

Operator

Our next question comes from the line of Mark Murphy with First Albany.

Mark Murphy, First Albany

Thank you, congratulations on a very strong quarter. You have talked about a target operating margin range of about 19% to 23% in the past, and as we think about our financial models for 2007 to what extent do you think those ranges should or could apply, or is the timeframe beyond 2007 for those targets?

John Schwarz, Chief Executive Officer

No, the range still does apply, it still is very much the target that we are driving towards as a company and Jim and I are particularly convinced that this is the right place for a company to be. I would say that we are on target to be in the range next year, though probably at the lower end of the range.

Mark Murphy, First Albany

Thank you. Just as a followup, Jim, as we try to estimate the organic license growth of the whole business for the third quarter, you helped us by providing the Firstlogic license revenue contribution, can you walk us through what the other adjustments would be to try to get an inorganic number?

Jim Tolonen, CFO, Senior VP Finance and Administration

No, it gets harder and harder and particularly a great example, and we talked quite a bit about this internally and I’ll give a specific example since I’ve already given some quotes on this on the call, if SRC Software has doubled in size post acquisition is that organic or inorganic? We’ve created that growth as a business by combining the product, putting it on the XI platform, etc. We believe all of that becomes organic quite quickly as we integrate these acquisitions. At a point early in the process, the first quarter or two we’ll be calling out what was the increment from the new company, but as they get fully integrated and become a part of the platform and the growth is really growth that we have created as combined business, that’s organic.

Mark Murphy, First Albany

Okay, so the number is hard to define but it would be better than the 5% decline you had in core BI, is that a fair statement?

Jim Tolonen, CFO, Senior VP Finance and Administration

That’s a fair statement.

Mark Murphy, First Albany

Thank you.

Operator

Our next question comes from the line of Mohammed Moawalla with Goldman Sachs.

Mohammed Moawalla, Goldman Sachs

Hi, just a quick question. First of all on this large transaction in EMEA, can you perhaps quantify the size of that?

John Schwarz, Chief Executive Officer

I can tell you it was bigger than $5 million. I cannot unfortunately tell you the customer name.

Mohammed Moawalla, Goldman Sachs

Okay, but it wasn’t greater than $10- million?

John Schwarz, Chief Executive Officer

It was not.

Mohammed Moawalla, Goldman Sachs

Just taking a step back and looking into sort of next year, obviously your organic growth has been slower than I think you anticipated given the weakest start to the year, as you look into next year with EMEA still having I guess more opportunities and the U.S. still at a fairly high growth rate, do you anticipate you can accelerate organic growth further into next year or should we expect the same sort of rate of growth to continue into next year.

John Schwarz, Chief Executive Officer

I would go back to comments that Jim had just made which is at some point in time organic versus acquired becomes a moot point. We are now a year down the road from SRC, three years down the road from Crystal, close to a year down the road from Firstlogic, and so these become part of our organic base for next year. That said, obviously core BI and the growth that we can generate from that platform is still very much a critical success factor for the business, and we believe that the core BI growth will return to more normal levels, meaning that we will continue to take share in this market place which is growing at 5%, 6% to 7%. And he reasons why we believe that this is possible is that we are seeing the level of take up of XI globally to reach levels where it will exceed the drop in sales of the down level versions of the software.

Jim Tolonen, CFO, Senior VP Finance and Administration

I’ll add one more thought to that just because we have commented on this a couple of times. So again the underpinnings there with XI revenue up 47% year-over-year, XI 2 getting great traction, I think it was up 34% sequentially, 80% of our total license revenue now on XI but we still have the declining older products of Business Objects 5 and 6 and Crystal 10 accounting for something like $20 million in the quarter. So they’re almost gone but a year ago they were $120 million. So, the growth in the newer products are being offset by declining purchases of the old, but even to this quarter people are still finishing projects on old ones, and with that decline we are starting to see the overshadowing of that by the underpinnings of the new product uptake in the continuation of migration.

John Schwarz, Chief Executive Officer

I’ll make another point Mohammed, which is that we told you last fall that we were planning our business performance roughly on or about 15% revenue growth for the year. If you look at our guidance, we are going to be right in that range at the end of the year. Even at the low end of the guidance we’ll show about 14% growth.

Mohammed Moawalla, Goldman Sachs

Okay, just a followup. As you look at sort of that core BI business next year growing at market growth rate and as you look at your pipelines, one of the sort of the levers there is just more of these large deals and potentially do you see more of these kinds of deals in excess of $5 million in the pipeline as you head into next year?

John Schwarz, Chief Executive Officer

You know, we also have a handful of deals of that nature in our pipeline. As you might imagine they take a while to mature. Often the decision cycles are relatively long so they are difficult to predict, but clearly customers are standardizing, customers are deploying business intelligence throughout the enterprise, customers are recognizing the value that they drive from these implementations, and the budgets that they are planning do allow for these large scale deployments. But just the same, I don’t want to suggest that we are building the business in the future on just hunting for elephants. We are absolutely investing in our channel, we also reached the mid-market or low end of the enterprise customer and are seeing growing rates that are just as good if not better there as we do at the high end.

Mohammed Moawalla, Goldman Sachs

Okay, that’s great, thank you very much.

Operator

Our next question comes from the line of Daniel Cummins with Banc of America Securities.

Daniel Cummins, Banc of America Securities

Thank you. Do you expect to give the calendar ’07 revenue guidance at the investor meeting in about 10 days?

John Schwarz, Chief Executive Officer

No, we will not. We will have an investor meeting early in the year where we will disclose to you the plans for the year as we did.

Daniel Cummins, Banc of America Securities

Okay, and I’m sorry I may have missed this before, Jim did you give the count of deals greater than $200,000?

Jim Tolonen, CFO, Senior VP Finance and Administration

Deals over $200,000 and less than $1 million in license revenues were 107.

Daniel Cummins, Banc of America Securities

Okay. My other questions have been answered, thank you very much.

Operator

Our next question comes from the line of Christopher Sailer with Goldman Sachs.

Christopher Sailer, Goldman Sachs

Thanks, my questions have been answered.

Operator

Our next question comes from the line of Nabil Elsheshai with Pacific Crest Securities.

Nabil Elsheshai, Pacific Crest Securities

Yeah, I may have missed this earlier but when you look at the guidance for the fourth quarter what contribution are you incorporating from ALG in that, is that something you can break out?

Jim Tolonen, CFO, Senior VP Finance and Administration

Yeah approximately $5 million in revenue but a loss, actually we detailed that in the press release and in the call in terms of the size of ALG anticipate to GAAP and non-GAAP. So $5 million in revenue, about $5 million loss on a GAAP basis and $1 million loss on a non-GAAP or pro-forma basis after purchase accounting elimination.

Nabil Elsheshai, Pacific Crest Securities

Then, on the XI upgrade cycle, do you have a sense on percentage of the install base that’s moved up and if you’re looking out to get to the 70% number which seems to be a pretty typical cycle, do you have a timeframe for that?

John Schwarz, Chief Executive Officer

We are nowhere close to 70%. Last quarter we closed at numbers we said that we were between 10% and 15% of penetration of the Object Classic and the Crystal space customers. We believe that both customer bases have moved up in penetration by about 5% in the quarter. The good thing about the rate of penetration is that it’s very steady in a consistent adoption curve and what we are seeing most satisfyingly is that the adoption is not only for customers simply migrating but also customers buying licenses and new technology at the same time.

Nabil Elsheshai, Pacific Crest Securities

Great, thank you very much.

Operator

And our next question comes from the line of David Wright with BMO Capital.

David Wright, BMO Capital

Thank you, good evening. Could you talk about the average size of the large deals, are they changing much over time, are they getting incrementally larger or are they staying about average?

Jim Tolonen, CFO, Senior VP Finance and Administration

I would ay that particularly this quarter we had a number of larger transactions, not just the one we’ve spoken about, and that the average size was probably 30% up from our typical average size; again that can be SKU’ed by one very large deal on a small number of transactions. I’d say historically they’ve ranged in the plus or minus $1.8 million to $2.2 million average size, and this quarter they were higher than that led by three transactions above the average.

David Wright, BMO Capital

Is there a sense that because they are getting larger they’re taking longer to close or are those things related at all?

Jim Tolonen, CFO, Senior VP Finance and Administration

Large deals do take longer to close, they’re complicated and there are more signature blots, and even these days sometimes we see a large transaction that ultimately gets broken up into two or three phases of implementation. We now it’s a large multi-order project and we do see a lot of our larger customers come back quarter after quarter. As you know about 75% of our total businesses are install base.

John Schwarz, Chief Executive Officer

I would say that had we had a very large deal signed in the second quarter rather than the third quarter as it did, we would have a much different conversation with you.

Jim Tolonen, CFO, Senior VP Finance and Administration

Just one last though on that because I think it is important, John commented, just a reminder that we are not particularly large deal driven. They are always important, they do make a difference, they often are hotly negotiated, clearly a few million dollars here or there often goes pretty much to the right bottom line, but our trend and in fact even this quarter is that somewhere between 15% or 20% of our license only revenue, maybe half that on a total revenue basis is driven by transactions over $1 million.

David Wright, BMO Capital

That’s helpful, thank you. On the declines in the core BI business, could you talk about the various factors that are causing the decline and maybe put some weighting to it like perhaps in the segment that you’re participating in, that segment is growing slower than the overall BI segment, maybe there are competitive factors and things like that.

John Schwarz, Chief Executive Officer

No, I would say that we are so broadly represented in the market place that our behavior and our performance mirrors the performance of the market overall pretty well. The key issue for us is the migration cycle. We have as you all know released the Business Objects XI platform last year. This platform is a major shift, a major new crank of the technology, and it does take some effort for customers to move. While the overall market is moving at about the rate and pace that we had expected to see, the fact is that in some cases and now diminished in a number of cases but in some cases earlier this year, we saw customers take a pause and spend their budget on the migration effort rather on buying new licenses. That seems to be less and less a factor but it’s still an issue that we have to deal with.

David Wright, BMO Capital

Okay, thank you very much.

Operator

Our next question comes from the line of Frank Sparacino with First Analysis.

Frank Sparacino, First Analysis

Hi guys. John, I was wondering maybe if you could comment – you had mentioned the migration programs put in place were beginning to have an impact and I’m curious if you would call out maybe one or two things specifically, and then as you go forward looking at ’07 is there anything differently you have planned in order to accelerate the migration?

John Schwarz, Chief Executive Officer

I would say the most immediate impact we had in the market was the creation of our migration project office. In essence if you really dig into the numbers and the performance that we’ve seen, the biggest single impact we’ve had was that the European customer was not prepared for the XI migration. So, putting in place the project office had allowed us to concentrate on the best skills, the best resources, the best experience we’ve had in one place so that we could put that energy behind the European sales, and that has made a tremendous difference in their ability to persuade customers to move. We’ve been able to build references, we’ve been able to bring our services to bear on the migration effort. We certainly have been able to overcome whatever inertia or reluctance there might have been. We’ve also put in place a couple of marketing programs which I believe will have a significant impact, but in a marketing context a quarter does not give you enough of a trend to be able to actually measure or predict. We’ve put in two things -- one is a specific marketing program targeted at the top 100 customers to incent them to migration to the XI platform by offering some assistance with services and with taking some of the risk out of the migration process. We have seen customers sign up but the leap time to actual deployment is still in progress. The second thing we did is announce a series of mid-market incentives both for the channel partners and for the customers, and again it’s a little early for us to be able to call victory there, but I’m confident these programs will have the desired effect.

Operator

Our next question comes from the line of Mike Abramsky with RBC Capital.

Mike Abramsky, RBC Capital

Yes, thanks very much. I’d like to just center in on your improved close rates, could you just give us a little color as to why and what you have done to improve those close rates, has it changed, how did you manage your approach of these rates in terms of sales execution?

John Schwarz, Chief Executive Officer

I would say the greatest majority of my answer kind of goes back to the answer I gave just previous to your question about the migration assistance we put in place. And secondly I think given the weaker performance that we saw in the second quarter, our sales team has done a much better job, qualifying, inspecting, reviewing, assisting the sales reps and getting the deals done, which is management focus, management execution, as well as the programs and assistance we put in place.

Mike Abramsky, RBC Capital

So, how has that affected your guidance I wonder?

John Schwarz, Chief Executive Officer

It has not affected it in a significant way. We are still forecasting the rest of the year at closing rates somewhat diminished from what we have historically seen, because again one quarter trend doesn’t make and so we are still being relatively conservative. It does give us confidence that we could raise the guidance by a little bit for the fourth quarter based on the pipeline and the closing rates that we are working with.

Mike Abramsky, RBC Capital

Thank you, and folks are speculating perhaps you’re not acquired, do you feel you can grow independently organically or it can be a point acquisition given the increasing focus in activity by SAP, Oracle, Microsoft in this sector, as well as some of whom you’re working with, will you need to make a big acquisition to remain independent?

John Schwarz, Chief Executive Officer

The market in which we operate is moving at 8%, 9% to 10% annually. We have the best solution suite in the market place, the broadest solution suite in the market place by far including these large new entrants that you have just named. We have a 15 or 16-year history of success of sequential growth both in revenue and profit. We have the best brand recognition of any BI vendor in the market place. We have a broader global channel and reach, but we feel very confident that remaining independent in this market place is a viable option for us and believe we can do so with or without significant future acquisitions.

Operator

Our next question comes from the line of Tom Roderick with Thomas Partners.

Tom Roderick, Thomas Partners

Hi, good afternoon, thank you. I was wondering if you might be able to comment just kind of looking at the services and maintenance margins here, they are improving nicely over the last two years when we look year-over-year. Can you comment a little bit on what the pricing for services and integration and consulting looks like out in the market place and is that ultimately what is driving your margins higher or is that just a mix shift towards more maintenance?

John Schwarz, Chief Executive Officer

No, let me break it down for you a little bit. Our margins in the maintenance business continues to improve as we get more efficient and as the quality of our product increases. So that’s kind of one aspect of the margins overall. Very importantly on the consulting/education services, our margins have traditionally been very low. We have been making good progress of increasing those margins into a more respectable and more acceptable range. We are far from being finished in that regard, but the margins are moving in the right direction. The reason that the margins in the consulting and education business are improving comes from two different sources or two different reasons if you will. One is that we have been able to get a slightly better price for the services that we offer because we have been focusing on taking deals where we can differentiate ourselves with a specific knowledge, a specific skill over what is generally available in the market place, and we’ve done I would say a better job of partnering with our systems integrator partners and VAR partners in a market place on picking and choosing the right engagements where we can make a difference. The second reason why we have improved our margins is that we have been getting better at managing the engagements ourselves and improving the utilization of the resources we have on board. We have become more flexible, our people have been more cross-trained, we have specialized better so we are able to apply people in more direct, more proficient, more effective, and ultimately more profitable ways.

Operator

Our last question comes from the line of Peter Goldmacher with Cowen.

Peter Goldmacher, Cowen & Co

Hi, can you guys talk a little bit more about some of the operational improvements you guys had made. I know you guys had talked about putting some skills out in the field, what have you done internally back at HQ?

Jim Tolonen, CFO, Senior VP Finance and Administration

Actually we’ve been running a program and we’ve been talking about it off and on for probably 18 months. It’s a program where I am the head of the steering committee and it currently has approximately 67 projects that are around the world and around all the functions, so there are opportunities that we are doing in terms of becoming a global business, we’ve hired a chief procurement officer for consolidating our purchasing and buying power, doing better negotiations on large contracts, we’ve re-negotiated some of our facilities leases at improved rates, we have focused our sales force on identifying the key accounts and the amount of resource to apply to the market opportunities, differentiated our business in terms of target by vertical market and by size of customer…I mean the list goes on and on…and then we see it in quality improvements, in service improvements, in price improvements, in margin improvements. Some of those savings we have opportunities to reinvest for improvement. For example, in product development, our India development center and China development center allow us to get a lot more hours of quality engineering overall for the dollars we do spend. We have only seen a small percentage of savings but we’re getting a lot more products out a lot aster, a large variety of things all of which we think continue to improve, and we’re just in the process of re-upping that. The original program was a ’05, ’06 to ’07 program. We still have identified savings, we know we will be achieving in ’07 and we’re gearing up now for the overlapping ’07, ’08. ’09 program. So the major effort is that it’s part of the DNA now, we call it our operational excellence of initiatives and they continue.

John Schwarz, Chief Executive Officer

All right, this is John Schwarz back, I’d like to thank you all for joining us on the call. I’d like you to give me a second just to summarize some of the key points we’ve made to make sure we’re all leaving this call with the same perspective. We are pleased with our performance. We’ve had strong performance in the Americas, EMEA is moving in the right direction, and APJ has become a turn around situation for us which has been very satisfactory. We are seeing good progress on all of our growth initiatives including the core BI, EPM, EIM, global services, and the mid-market, and we are continuing to see the leverage of scale of the business on the profitability of the company, though we are demonstrating and sharing with you confidence in our performance outlook and I’m looking forward to having a similar discussion with you at the end of our fourth quarter. Thank you very much for your time and have a great day.

Operator

This concludes today’s Business Objects third quarter earnings results conference all, you may now disconnect.

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Source: Business Objects Q3 2006 Earnings Call Transcript

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