BEA Systems F3Q07 (Qtr End 10/31/06) Earnings Call Transcript

Nov.16.06 | About: BEA Systems (BEAS)
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BEA Systems (BEAS)

F3Q07 Earnings Call

November 15, 2006 5:00 pm ET

Executives:

Kevin Faulkner, Investor Relations

Alfred Chuang, Founder, Chairman, CEO

Mark Dentinger, CFO

Analysts:

Adam Holt, JP Morgan

Sarah Friar, Goldman Sachs

John Walsh, Citigroup

Katherine Egbert, Jefferies & Company

Heather Bellini, UBS

Keith Weiss, Morgan Stanley

Robert Breza, RBC Capital Markets

Terry Tillman, SunTrust Robinson Humphrey

John McPeake, Prudential Equity

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 Third 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. 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. Faulkner your may begin your conference.

Kevin Faulkner, Investor Relations

Thanks Marvin. Good afternoon, ladies and gentlemen, and thank you for joining us as we discuss BEA Systems, Inc. results for the third quarter ended October 31, 2006. Please note we posted our earnings press release on our website 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, opportunities, 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 in our fourth 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 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.

As previously announced, BEA is in the process of conducting an internal review of our historical stock options. The audit committee is leading the review with the assistance of independent counsel and they have not provided an estimated date of completion. We have been advised that the best practice is to provide only select highlights and not provide preliminary GAAP expenses and EPS because it is possible that those financial measures could change as a result of the investigation.

In addition, we are not able to provide our normal non-GAAP measures because SEC regulations prohibit us from reporting non-GAAP measures unless we concurrently report the corresponding GAAP data. We do, however, wish to communicate as much financial data as possible and also to update investors on several key points about the company’s business.

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, Founder, Chairman, CEO

Thanks, Kevin, and good afternoon everyone. We are pleased to report third quarter results that are within the range of expectations we set on the last earnings call. Both our AquaLogic product and also our SOA services continue to lead customer opportunities. SOA adoption continues to expand and increase in complexity.

BEA is the only company with two unified SOA platforms. In the third quarter, we announced SOA 360, the next step in our product strategy to support advanced SOA projects. In the third quarter, we also announced the revolutionary new Guardian service offering, and today I’m pleased to announce a bundling relationship for our communication products with Huawei Technologies, one of the leading network equipment providers in China. We’re optimistic of our business as we head into the seasonally strong fourth quarter.

Let me give you some details of our third quarter performance. Revenue was $348 million, up 19% year-over-year. License revenue was $136 million, up 12% from a year ago. Service revenue was $211 million, including $167 million of that in maintenance revenue, up 23% from a year ago.

Customers that are buying BEA technology in the third quarter included eBay, Blocbuster, Capital One, Citigroup, Hilton Hotels, Monster.com, Pfizer, Sabre, and Taiwan Mobile.

Deferred revenue is up $34 million compared to last year, now standing at $338 million.

Now let me set the guidance for the fourth quarter. Based on current business condition, we forecast the fourth quarter total revenue to be in the range of $378 million to $392 million. Later on in this call, Mark will give you some more details on the financial performance and also our fourth quarter guidance.

Now, let me first turn to business. We had strong performances in a lot of areas, particularly in some geographies and product areas. However, we continue to see some challenges in certain few locations. We’re confident that we have addressed many of these issues. We anticipate improvements in these areas going into the fourth quarter.

In addition, we experienced a few isolated transactions where a portion of the license revenue was required to be placed on the balance sheet as deferred revenue due to the administrative structure of these orders. These portions of the contracts will be recognized as support revenue over the life of the contract.

In the third quarter, we signed 17 $1 million and above license transactions, compared to 19 a year ago. The total number of license orders received in the quarter were 2460, which is up by about 10 compared to last year’s third quarter and up by 40 compared to this year’s second quarter.

We’ve seen sustained strength in our business in several territories over the last few quarters, particularly in the Nordics, our U.S. East and Federal territories, and emerging growth areas like China, India, and Korea. We’re excited about our opportunities in these emerging areas and are increasing our investment in those places.

We’ve supplemented our China Telecommunication Technology Center with new centers in Korea and also in Bangalore. We have expanded our presence with a global partnership with Tata Consulting Services.

So, let me give you some comments on the market environment. SOA is moving from exploration phase in Enterprise Y deployments, limited only by the imagination of early adoptive customers. We’re seeing a steady increase in multimillion dollar SOA projects throughout the world. The last time I saw this kind of excitement was in the very early days of Java. With SOA that’s an important difference, is being funded and driven by the business and not just IT.

A recent research report shows that 60% of all SOA funding is driven by the line of business. That’s very encouraging news since it serves to expand BEA’s overall addressable market beyond the traditional IT middleware budgets. And BEA is targeting its selling efforts to this audience. We’re strengthening on focus on selling at the CIO level and selling to the business units. One example is the CIO front that we held at BEAWorld in San Francisco and also in Prague.

There’s another positive signal emerging in the market place. We are now seeing strong interest in projects in mainstream industries like insurance and also in retail; again a big difference from where we initially saw Java demand. We believe that SOA is poised to move out of the early adoption phase into the mainstream imminently.

As a result, we made a number of aggressive moves this past quarter to enhance BEA’s position to take advantage of this market opportunity. We unveiled at BEAWorld in San Francisco a multi-year billion dollar initiative called SOA 360. SOA 360 will be the industry’s most unified SOA platform for business transformation and also for business optimization.

Any platform demands two things -- a common architecture and also common tooling to expand the platform. SOA 360 platform starts with unifying our three product families under a common native SOA architecture, which we call the Micro Service Architecture or short name is MSA.

Over the last 18 months, our own development teams began to componentize WebLogic, AquaLogic, and Tuxedo products into reusable building blocks, components that will allow us to rapidly assemble products like we’ve never been able to do before.

I’ll give you a couple of examples of the power of this approach. So, we were able to demonstrate our AquaLogic Data Services platform running in an embeddable footprint of under 35 megabytes, and our engineers took days instead of typically months or years to do this.

I’ve seen simple MSA-based products that are small enough to email to each one of you. Not only is it a stunning technology, it also means that we can take SOA to the edge of the network and devices and footprints that we never before believed were possible.

We are in the process of documenting the architecture and plan to make it widely available to partners and customers so that they can contribute and also to benefit from this architecture.

The second part of SOA 360 platform is the WorkSpace 360. WorkSpace 360 will be an industry first tooling environment that spans the needs of the developers, the architects, system administrators, and even business analysts. So why is it so intriguing? Today, we see developers using Eclipse tooling such as a workshop product line, business processes being created in Visio and deployments being managed using a tool like OpenView.

Individually each one of these tools is excellent, but there is no tool today that brings together these separate views into an end-to-end collaborative environment. WorkSpace 360 will support BEA’s three product families and over time will also support third-party products as well.

We demonstrated WorkSpace 360 on stage at BEAWorld showing how customers can navigate seamlessly between business process flows, deployment monitoring, all the way down to writing Java code. And the collaborative power of the environment is based on Web 2.0 technology featuring search and indexing capabilities, visualized in ways that facilitate and benefit social networking and also good collaboration.

We’ll be unveiling more information about WorkSpace 360 product family next year. I encourage you to look at the first reports that Gartner reported, and they clearly underscore why BEA expects to have a strong competitive advantage with SOA 360 and Micro Service Architecture and also WorkSpace 360.

So, in the third quarter we also announced a new release of WebLogic Integration, WebLogic platform, AquaLogic BPM, AquaLogic Data Services platform, AquaLogic Enterprise Repository. BEA has the only unit like out of the box SOA platform product that is the best performing middleware and we continue to expand an improve on that.

So finally, the last major BEAWorld announcement highlight is Guardian. Guardian is an innovative product from BEA that will totally change the way supports are delivered in the industry. Guardian is the industry’s first technology-enabled support offering which will move traditional customer support beyond reactive and proactive measures to what we call preemptive measures.

So, in plain English, Guardian is able to scan customer environments and compare them to a knowledge management repository or stored deployment paths, and Guardian is able to recognize trends with known problems and it offers suggestions in the form of patches or also implementation tuning in the event of any problems occurring.

This is truly revolutionary in this industry and will extend BEA’s leadership in software support offerings. Guardian is in beta today and is scheduled to become generally available for sale this quarter.

So, now let me turn to our product results from the third quarter. AquaLogic had an outstanding quarter led by the Service Bus and Business Process Management products. In the third quarter, AquaLogic license revenue once again represented more than 20% of our total license revenue.

AquaLogic products were included in 12 of our 17 $1 million plus transactions. AquaLogic customers in the quarter included…InterCall, Vignette. Our AquaLogic Data Services and Service Bus products had a year-over-year revenue growth every quarter this year, and revenue from AquaLogic BPM products nearly doubled from the second quarter to the third quarter.

Flashline, now what we call AquaLogic Enterprise Repository, made a solid contribution in its first quarter. The repository is a very important piece of technology to the SOA development and reuse environment, and it’s an important component in our WorkSpace 360 strategy.

AquaLogic BPM received two standalone orders over $1.5 million each. One was an all IBM account, continues our success of using AquaLogic as an entry point into new customers. The other order was in the BEA global account that we’re seeing increasing interest for our BPM products in our global and enterprise environment.

Our services organization also played a very key role in expanding our SOA capabilities. Our SOA consulting services again successful drove new customer opportunities and accelerated the license deals. In particular, two consulting engagements demonstrated this pull through of service to license.

A U.S. retailer is in the process of refreshing their online store, revamping every IT process in the company. We will begin with a SOA consulting engagement working with the customers on defining their organizational structure to align for an SOA implementation. The team has now begun phase II which is working on building reference architectures and creating solutions around the customer’s existing IT assets.

In the fourth quarter, we’re expecting to complete the migration assessment covering migration to the current version of our products switching from AIX to Linux and replacement of the store front base on…of and ISV application.

Another example is the Nationwide U.S. Bank, a big bank. Our SOA service is the cornerstone for a competitive win against IBM for an SOA mega project. The bank has been challenged with unifying multiple lines of business under a portal and SOA architecture to consolidate the proper customer interface to the bank and a variety of products and services. SOA services led a win in an account that has $500 million multi-year contract with IBM, and as a result of this win BEA is establishing portal and SOA architecture status within the bank’s global corporate and investment organization.

We will believe this work will open doors into other projects in the bank and also represent million of dollars in additional opportunities.

I’m very excited about the progress we have made in our WebLogic communication platform business. In the third quarter, we completed a multimillion dollar transaction with a big U.S. wireless carrier. We expect to be able to recognize revenue from this transaction ext year.

In addition, we received a multimillion order from InterCall, the service which is hosting this call as a follow on to the implementations that we began last year. Total orders and recognized revenue grew substantially from the second quarter to the third quarter.

Recognized revenue in the third quarter was in the multimillion dollar range but still represents less than 10% of our orders.

We continue to advance the products based on the market and customer requirements. In the first quarter we announced the creation of our China Telecommunication Technology Center, which we internally call TTC. The China TTC was created to build and localize communication products for the China market, initially just focusing on 3G and IMS technology, working directly with the network equipment providers and also the different operators.

This quarter, the China TTC delivered two significant products -- one is the Service Access Gateway, and second is the WebLogic Conference Server. The Service Access Gateway is a platform that runs on top of WebLogic Network Gatekeeper enabling partners to rapidly build applications that run on the network.

WebLogic Conference Server is an IMS presentation for multimedia conference applications like voice and video. The China TTC has done interoperability testing with several major network equipment providers. They include VTE, Huawei, Nokia, Lucent, and Motorola, and we have agreements with these vendors to work on IMS solutions.

Both of these new BEA products are the in the proposal stage with a major Chinese carrier in conjunction with several of our partners. In addition, the China TTC is working directly with several carriers on a new standard called a TDS CDMA, which is the China standard for 3G services. Also, the China TTC is working with several carriers for IPTV home networking, data services for small and medium-sized businesses, all very exciting things.

As I mentioned at the top of the call, we’re making a significant partner announcement today, Huawei Technologies, one of the largest network equipment providers in China has ended into a bundling relationship with us for IMS solutions, and is working very closely with the China TTC.

Under this agreement Huawei is bundling BEA software into their hardware purchasing from us a standard price and reselling our software on the box. We expect to announce additional bundling relationships with other network equipment providers at the ITO Telecommunication Conference in Hong Kong and BEAWorld Beijing in early December.

We expect these partnerships over time to improve our market penetration. There is an increasing need of our technical resources in the selling process and obviously also to speed revenue recognition.

So, before I turn the call over Mark, let me summarize. Here’s what I see as the key themes of the quarter. First, BEA delivered our sixth consecutive quarter of year-over-year license revenue growth and fourth consecutive double-digit year-over-year license growth rate.

Second, although we can’t share the financial details at this time, BEA continues to improve the efficiency of our operations.

Third, results were driven by strong organic growth, particularly from AquaLogic Service Bus, Tuxedo, and other areas supplemented by growth from our key acquisitions.

Now, let me turn the call over to our CFO Mark Dentinger for more details on our third quarter performance and also on the guidance. Mark…

Mark Dentinger, CFO

Thank you, Alfred. As previously discussed our audit committee is reviewing our historical stock option granting practices. Because the review is ongoing and the accounting impact if any on current prior period financial statements is uncertain, we are limiting today’s discussion to financial measures which are unlikely to change as a result of the review.

Additionally, our forward-looking financial guidance will also be limited principally to certain revenue measures until the review is complete.

Revenue for the quarter was $347.7 million, up 19% year-over-year. License revenue was $136.4 million or 39% of total revenue, and services revenue was $211.3 million or 61% of total revenue. The largest component of services revenue, customer support, was $166.9 million, a 23% increase compared to last year's third quarter. Consulting and education revenues were $44.4 million in third quarter, up 27% from last year.

Geographically, the Americas region generated 55% of our third quarter revenue and our international businesses contributed 45% of total revenue. The Americas' contribution was 2 percentage points higher than the third quarter of last year. Internationally, our EMEA business contributed 30% total revenues, a 1 percentage point decline from a year ago, and Asia-Pacific was 15% of revenues, a 1 point decline from the third quarter of a year ago.

A portion of the year-over-year change in distribution is because the predecessor entities of our Business Interaction Division were not part of BEA for most of last year’s third quarter and BID currently generates most of its revenue in the Americas.

The third quarter total license transaction count of 2,460 was approximately even with last year, a 2% improvement from the second quarter of this year, and our average transaction size increased approximately 12% compared to last year. For the third quarter, industry vertical performance was as follows: telecommunications 22% of license revenue, services 19%, government 17%, banking and finance 16%; other verticals were individually less than 10% of license revenues for the quarter.

Our third quarter revenue would have been approximately 2% lower if we had translated the current quarter at currency exchange rates in effect last year. When comparing to the second quarter of this year, our third quarter revenue would have been essentially unchanged if we had translated at last quarter’s exchange rates.

Now, let me address our balance sheet. We ended the quarter with cash and short-term investments of $1.4 billion and cash flow from operations was $52 million in the third quarter compared with $65 million in the third quarter of last year and $50 million last quarter. Year-to-date our cash flow from operations is improved by more than $20 million from last year, but we are now absorbing the impact of becoming a U.S. tax payer which is the primary reason that our cash flow improvement has trailed our profit improvement and will likely continue to do so until early next year.

During the fourth quarter we are scheduled to repay the remaining $255 million of our outstanding convertible debt and as a result the fourth quarter ending cash and debt balances will likely decline from their third quarter ending levels.

DSO for the quarter was 71 days, 6 days lower than last year. Deferred revenue increased by about $35 million from last year and now stands at $338 million.

The largest component of our deferred revenue, deferred support, historically has tended to sequentially decrease slightly during the first three fiscal quarters and increase significantly during the fourth quarter, principally as a result of the timing of support 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.

Without addressing our overall cost and expenses for the third quarter, I will now discuss certain expense measures and other phenomenon from the third quarter to assist in your model. Non-GAAP other income and expense or OIE increased to $9.5 million in the third quarter versus $3.6 million in the third quarter of last year and $8.6 million in the second quarter of this year.

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

Total head count increased by 113 during the third quarter and we exited the quarter with 4244 employees. We plan to very selectively add head count during the fourth quarter with an emphasis on our high growth areas in Asia.

We also incurred almost $2 million during the third quarter for external expenses associated with the options review and we will likely incur a similar amount in the fourth quarter. Additionally, we absorbed a $4.4 million non-cash charge during the third quarter associated with modifying stock option awards for departing employees and employees with expiring options. Because modifications will continue to be required while the review is open, we expect another charge in the fourth quarter. Please note that neither of these charges includes any possible restatement or related tax effects that might impact the current period results following completion of the options review.

In the third quarter our non-GAAP tax rate is expected to rise to approximately 33.5% based upon our current estimated distribution of earnings for all of fiscal 2007. Our third quarter GAAP tax rate will rise to approximately 36.5% based upon a combination of a shift in earnings mix, the impact of acquired in-process research and development from the Flashline acquisition, and the tax impact of modifying the stock option awards in the third quarter.

Our diluted weighted shares outstanding during the third quarter increased to 414.7 million, an increase of more than 7 million shares from our the second quarter number and up almost 20 million shares from last year’s third quarter. The primary driver for the increase was the treasury method effect of a higher average stock price on our outstanding options.

I will now discuss our guidance for the fourth quarter. The following comments on guidance are forward-looking statements as are any other comments about our future financial and product performance. You should review our 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 large license transactions 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 upon current business conditions and information we have as of today’s call, and 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 of comments on future performance. If we do update our comments on guidance, it is BEA’s policy to do so through appropriate public disclosure.

In determining our guidance we are not assuming any significant change in the global economic climate or IT spending levels in the near term. Finally, our comments on guidance do not address any additional cost and expenses which may have to be absorbed in future financial statements if prior period results are required to be restated following completion of the options review.

Based on these factors and current business conditions, we anticipate that revenues for the fourth quarter will be within a range of $378 million to $392 million and that the license component of revenue will comprise 42% to 45% of total revenue.

As I previously mentioned, we also expect to incur additional expenses in the fourth quarter for a combination of third-party fees for conducting the options review and non-cash charges associated with modifying expiring stock option awards.

We also anticipate paying a one-time non-executive employee bonus during the upcoming holiday period which will add approximately $9 million to our normal variable compensation expenses in the fourth quarter.

Excluding the possibility of any restatement related effects based upon the current distribution of earnings, we would expect our fourth quarter non-GAAP tax rate to be 29.5%.

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

Alfred Chuang, Founder, Chairman, CEO

Thanks, Mark. BEA delivered a double-digit year-over-year license revenue growth rate for the fourth consecutive quarter. License revenue growth continued to enable us to improve the efficiency of our operations. We are the leader in application servers and now clearly SOA, and we are expanding our performance lead delivering innovative new products into growth markets like SOA and the next-generation telco services.

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

Kevin Faulkner, Investor Relations

Thanks. Marvin, we are ready to take questions from the audience.

Question-and-Answer Session

Operator

Ladies and gentlemen, if you would like to ask a question at this time please press * then 1 on your telephone keypad. Our first question comes from the line of Adam Holt with JP Morgan.

Adam Holt, JP Morgan

Good afternoon. I had two questions about organic growth. Alfred, you had said that you had strong organic growth in a number of areas. Understanding you’re not giving detail on maybe some of the line items on revenue, if you could tell us sort of what the range was around organic growth? And secondly, can you talk a little bit about the WebLogic Server standalone business, was that plus or minus in the quarter and what were the factors there?

Alfred Chuang, Founder, Chairman, CEO

Adam thanks, good afternoon. First of all, the AquaLogic family of products particularly on BPM and on the Service Bus continue to see great strength in the market place and they grew very aggressively. A little less than about half of AquaLogic used to be acquired products but it’s been time and we have done a lot of work over these products, so it’s kind of hard to tell exactly what was acquired and what was precisely organic. But there is no doubt in our mind, almost practically all of these were originated concepts from us and most of these things that we’re doing, especially Service Bus, which is one of the fastest growing components we have in the core is all organically developed. From a WebLogic Server perspective, we saw about the same level of performance from the prior quarter. It may have a very, very slight bit of decrease compared to the previous quarter but there’s nothing at this point in time what is really changing, because we also are doing some of our own allocations when we’re doing some of these larger transactions between WebLogic and AquaLogic product lines. So, I think from a product perspective it really hit very, very solidly in the quarter.

Adam Holt, JP Morgan

In fact if I could just ask to a followup maybe from Mark, if you look at the midpoint of your guidance for the fourth quarter and the range that you gave around license revenue and applies a number that’s higher than the current consensus, maybe you could walk through what gets you comfortable with a number that’s sort of above where the street is already looking for?

Mark Dentinger, CFO

Current assessment of business conditions, Adam. Right now there’s no reason why we should not have a typical seasonally strong fourth quarter based on all of the metrics that we’re currently reading, but the fourth quarter is also a big quarter for us, we got to process a lot of orders, all of that stuff comes into effect in our assessment, but right now we’re reading the tea leaves that we see inside the company.

Adam Holt, JP Morgan

Okay, thank you.

Operator

Our next question comes from the line of John Walsh with Citigroup. Mr. Walsh, your line is open.

Kevin Faulkner, Investor Relations

Marvin, please move to the next one.

Operator

Our next one comes from the line of Sarah Friar with Goldman Sachs.

Sarah Friar, Goldman Sachs

Good afternoon guys. Two questions for you, it seems like EMEA was still a little weak this quarter, and I know actually last quarter I think it was from Germany specifically. Could you talk a little bit, Alfred, about what you’re doing to try to get Europe back on more even keel?

Alfred Chuang, Founder, Chairman, CEO

Hi Sarah. In fact EMEA did not perform to the level that we were hoping for in the quarter. We actually had made two different changes in the quarter, one early on in the quarter that we had decided to change out the head of the U.K., and then when the quarter ended what we have decided now is to put a new person in charge of our EMEA operations with somebody who is very seasoned from within the company and who has been for a very long time, a very, very strong player. So, we expect to see turn around in the region. Germany actually turned out quite a bit in the last couple of quarters. The same person who helped us turn around Germany is now running Europe, so we have a lot of confidence and I think we’re going to see better days in Europe upcoming.

Sarah Friar, Goldman Sachs

And then just the Huawei relationship, how soon do you think we can start to see revenues from that come in, is it as early as the first half of next fiscal year or are we looking to the second half of next fiscal year?

Alfred Chuang, Founder, Chairman, CEO

I think the element of how fast we’ll be able to see the Huawei performance is a couple of things. One, is the rollout of the 3G technology in China itself and also some of he IPTV and some of the broadband-based technology being rolled out. And as you know, they’ve been waiting for the 3G license to be awarded and one of the telecom is going about basically establishing sort of their own standards and making things happen. We’re well embedded in just about everyone’s box and the Huawei bundling announcement I think is a very, very big deal. We are not aware that they have done this kind of deal with anyone else in history. We’re very happy that we’re able to do this. They have an enormously strong position with all the big telcos in China, so I think we could see some benefits of this deal exiting the first quarter or into the second quarter. So, I think we’ll see some good stuff. 3G licenses rollout, I think it’s going to begin in January.

Sarah Friar, Goldman Sachs

Okay. And maybe just one quick one as a followup to that, in general in the quarter for WLCP overall, did you see deals in the U.S. or Europe on WLCP platforms?

Alfred Chuang, Founder, Chairman, CEO

Much between U.S. and also in Asia, so both of those regions have done very well in terms of bookings of the WLCP deals. I’ve explained this in the past before, recognition of the WLCP deals are somewhat contingent to some of the custom things that they do because historically this technology is embedded in the System 7 layer stack and now we’re replacing with open systems. So there are a lot of custom technologies that are required to make that work, and I think we’re in the early phase of making that all standardized. So, these deals will get recognized over the next year, and I think we’ve done well in terms of booking these deals. I think this quarter the Americas did very well, bookings on wireless providers going into preparation for some of the things that we’ll be seeing in multimedia and possibly 3G in the U.S., and then the second part is really Asia which has done a very, very good job with that technology.

Sarah Friar, Goldman Sachs

Okay great, thank you for the color.

Operator

Our next question comes from the line of John Walsh with Citigroup.

John Walsh, Citigroup

Okay great, sorry I don’t know what happened there last time. Just a followup on that last question, WLCP, when you say bookings is anything showing up in the financial statements? You said there is some recognition of revenue but is the other portion of bookings that you’re talking about, is that affecting the balance sheet at all?

Mark Dentinger, CFO

Most of it is not John. We are picking up some recognized revenue in the current period. It’s relatively small at this point, Alfred alluded to that fact.

Alfred Chuang, Founder, Chairman, CEO

With deals that were sold in the past.

Mark Dentinger, CFO

Right, with deals sold in the past. So, we’re now seeing the trailing effect of those, but the current deals that sold most of that does not show up on the balance sheet. Most have either taken orders, the future deliveries are out there. In a couple of cases we get advanced cash but only in those cases does it actually show up in our…

Alfred Chuang, Founder, Chairman, CEO

But John I think it’s important to understand that from a customer’s perspective they sign a deal just like any other deal. It’s just the rack requirements because they have some components in there will not allow us to put in anywhere. So, to us it’s nothing more than a letter of intent, but to the customer it’s an order. They place a big multimillion dollar order and we’ve got a bunch of them, but we will see them recognized over the next year.

John Walsh, Citigroup

Great, and on the expense side you’ve not given full detailed expense, but can you give us any additional color on the current quarter level of expenses and then also I think you had mentioned in the fourth quarter not only the options review expense but a bonus, is that a cash bonus, I think that you spoke about $9 million?

Mark Dentinger, CFO

That’s right. It is a cash bonus one time to the fourth quarter. So, if you’ll look at your classical modeling where you’d see an uptick in expenses in the fourth quarter principally associated with accelerated variable compensation rates and so on and so forth, you should model in something for a one-time bonus above and beyond that. And with respect to the rest of the expense picture, the best practice right now is not to get into too much detail, but we try to give as many details as possible on other financial and non-financial measures to allow you to at least to assemble rational models.

John Walsh, Citigroup

Okay. And the rationale for the one-time bonus above that?

Alfred Chuang, Founder, Chairman, CEO

John, the rationale for the one-time bonus is I think the company has performed very well in the year. The board of directors and the management has gone into several dialogues about what we can possibly do for the employees. These employees are non-VPs. So VPs and above don’t get anything. It’s a flat bonus of about $2000 per employee, and this is just a recognition of the job well done by the employee base for the year.

John Walsh, Citigroup

Okay, great thank you.

Operator

Our next question comes from the line of Katherine Egbert with Jefferies.

Katherine Egbert, Jefferies & Company

Hi, good afternoon. I have a question on the deferred revenue. They were down again quarter on quarter. I thought I heard you say that you were deferring more revenue of late, but there were some deals delayed, and then also you’ve grown your license revenues in the last two quarters, so why is deferred revenue down?

Mark Dentinger, CFO

Katherine, the biggest decline in deferred revenue in the third quarter which is entirely within normal expectations is deferred support. It’s not the license component deferred revenue. That’s actually about neutral on the quarter, and in fact the $18 million decline in deferred revenue for the second quarter to third quarter period is almost entirely deferred support. And in fact if you correct for exchange rates in the second quarter, that was approximately the same decline we expected going from the first quarter to the second quarter. And actually if you correct for the Plumtree acquisition in last year’s second quarter to third quarter, you would also see a sequential decline. I made the general statement and I do every quarter just to remind everybody that we actually expect to see sequential declines in the deferred support revenue from the first quarter to the third quarter and then you get this big spike in the fourth quarter when you get all of the renewals, the annual support contract renewals coming through. So, the decline in deferred revenue was actually within normal expectations and if you correct for the two phenomena I mentioned with respect to the second quarter and last year’s third quarter you get a fairly expected normal sequential decline.

Katherine Egbert, Jefferies & Company

Okay thanks Mark. Next question, given that you didn’t give us many operating metrics, can you break out for us what business interaction was, what WLCP was versus your more legacy products?

Mark Dentinger, CFO

We don’t actually break those out other than…Alfred did give you some color on the AquaLogic product line performance of which business interaction has components in that line, but we don’t actually break down further than that.

Alfred Chuang, Founder, Chairman, CEO

Katherine, just let me repeat a little bit of what I said earlier. The AquaLogic component of the license revenue is about 20% of our total license revenue. WLCP is less than 10% of our total license revenue. So, you would imagine the reference really to traditional products. That pretty much is all the breakout that we really can derive because of the way that we sell today.

Katherine Egbert, Jefferies & Company

Okay, I appreciate that. Last question, do you have any visibility when you could wrap up this investigation, maybe give us an update whether you’re in the investigative process or kind of the corrective process on the options restatement? And then if you’re in that corrective process, can you tell us when it might wrap up?

Alfred Chuang, Founder, Chairman, CEO

Katherine, I’m going to make a general comment and then I’ll let Mark comment on this. First of all, the people heading up the investigation are the audit committee and our board of directors. The management team really has no insight into the investigative process itself. This is how it’s conducted by law. And from the news that we have gathered from our board of directors is we’re looking at a major milestone to determine where we’re at in the mid-late December timeframe. Everyone in the company is very anxious to get this over with, and we’re hoping that we’ll get some major breakthrough at the end of December, but that’s all that I know of.

Mark Dentinger, CFO

We’ll certainly keep you posted as we know more, but Alfred is absolutely right. The scope and the nature of the investigation is in the hands of our board of directors and the best we can do at this point is cooperate as best we can to get it over as soon as possible, and trust me we’re all very anxious to get it behind us.

Katherine Egbert, Jefferies & Company

Okay, thanks.

Operator

Our next question comes from the line of Heather Bellini with UBS.

Heather Bellini, UBS

Hi, thank you. Alfred, I had two questions. The first would be if you could talk to us about the type of growth you’re seeing and expect to continue to see in your core WebLogic and Tuxedo businesses. And secondly, looking at fiscal year ’08, I know you guys haven’t given formal guidance, but on various occasions over the last six months you’ve kind of set an expectation for 10% to 15% top line growth, could yield about 200 to 400 basis points of margin expansion. How comfortable are you with those targets still which you guys have kind of thrown out there in light of this quarter? Thank you.

Alfred Chuang, Founder, Chairman, CEO

Heather thanks for the questions. On the question about the WebLogic Server and Tuxedo, firstly I will go into the fourth quarter. So traditionally a lot of customers renew their enterprise license agreement on WebLogic and Tuxedo in this quarter. So, we’re going to see a strong performance in both Tuxedo and WebLogic in the quarter. Tuxedo is a technology that is now used also for a lot of the mainframe re-hosting, something that we hoped about 10 years ago and finally it is happening. So, we do expect some growth based on that going into next year, but it is a technology that has been around for a long time. You know, WebLogic Server is a different story. We see enormously more interest in the WebLogic Server business lately and I think it’s just an element of some of the softness of some open soft technology in the market place, some of the chaos in that area that has been created. And clearly WebLogic Server’s performance is outstanding and I think at the end of the day that translates as a total cost ownership, so you buy a lot less boxes, incur a lot less maintenance cost, a lot less supporting cost, and a lot less operational cost when you have a technology that is so reliable and works so well, and this performance is so stunning. The benchmarks don’t lie. I think that clearly is the feedback that the customers are sending us. In terms of the market, I’ll let Mark to mention. I think we’re confident at this point in time that this metric still works.

Mark Dentinger, CFO

Yeah actually the way Alfred phrased it right, Heather, that we actually weren’t commenting so much on the forward view of revenue, we will need to digest that as much as we were commenting on how we think our model behaves in response to revenue outcomes, and that’s an important distinction, and Alfred is absolutely right. We still believe that that’s essentially the sensitivity to our model to different revenue outcomes.

Heather Bellini, UBS

Okay, so that 10% to 15% would yield 200 to 400 basis points of margin expansion still?

Mark Dentinger, CFO

Yeah, if all other things being neutral, right.

Heather Bellini, UBS

Okay great, thank you.

Operator

Our next question comes from the line of Keith Weiss with Morgan Stanley.

Keith Weiss, Morgan Stanley

Hi guys, thanks for taking the question. In recent quarters, both IBM and Oracle talked about some pretty strong application server growth. Could you talk to us a little bit about the competitive environment against those guys as well as a little bit about the ability to pull through WebLogic sales with some of the AquaLogic product sales that seem to be still growing pretty strongly? Thank you.

Alfred Chuang, Founder, Chairman, CEO

Hi Keith. The competitive environment really hasn’t changed that much. We obviously had some very exciting IBM conversions in the quarter and we broke into some of IBM marquee accounts that they have pounded their chest on. We’re very proud of our team that we are able to go do that. Oracle, I don’t know how to compare. They stopped breaking out the middleware revenue and they’ve kind of put a benchmark out, they didn’t pass the test and it got kicked out. I don’t know what they have. I think they are formidable competitor, also a partner in many areas, you know we have tied with them a lot in the database arena, and honestly I think at this point in time we have one key competitor and that is IBM, and it really hasn’t changed all this time. We’re hearing a lot less noise around open source. This really is the competitive environment. I think in some ways it’s encouraging. I think it’s really up to us how to break the SOA world into the mainstream and getting people to deploy big stuff and continue to sell well into the line of business, move more into solution selling than selling technology, and I think we’re working very hard on all of that.

Keith Weiss, Morgan Stanley

Excellent. And maybe just one followup, you guys have been talking for sometime about investment in Asia-Pac, when do you think we could start seeing that come through with accelerating growth rates over there?

Alfred Chuang, Founder, Chairman, CEO

Asia is growing 50% plus year-over-year. I think that breaks any record I ever seen in any region. As I mentioned in the previous quarter that China is now bigger than Japan for us, and it’s now our biggest region in the Asia-Pacific arena, and I think it will continue to roll. It’s a place that is just doing so very well and we’re expanding our investment in the country, TTC has done so well in terms of embedding a lot of our technologies into the number of equipment providers. We’re winning huge deals in telcos, in the banks and government. So, I don’t think that will be stopping. We’ll also see some stunning growth in other places that are smaller in base like India, Korea, which a lot of our peers would have a very difficult time breaking into. So, I have very high aspirations for Asia-Pacific. I think if its growth rate continues to go on we’re going to see a huge top line change in our company over time.

Keith Weiss, Morgan Stanley

Okay, thank you guys.

Operator

Our next question comes from the line of Robert Breza with RBC Capital Markets.

Robert Breza, RBC Capital Markets

Hi, good afternoon. Alfred, I was wondering if you could talk a little bit about the verticals and specifically I was looking at the telco vertical and some of the year-over-year perspective, it appears about flat, is that where you expected it or was some of the delay in revenues affecting that growth rate, can you just give us a little color there?

Alfred Chuang, Founder, Chairman, CEO

Telcos spent big in the fourth quarter, so that’s not that unusual, and we are seeing about 18% of our sales in telco, and I think it’s pretty much consistent to what we’ve seen in the past. Some of the revenue from the WLCP product we’ll see next year, so it will add to that growth, and these deals that we have booked are waiting for recognition. So, it’s just a matter of the time that they deploy the actual project itself. So, I think we’re very confident. We are seeing some interesting vertical that is coming up pretty quickly that we are opening out, though one is insurance. Historically, it’s a very blue and very old technology. They are investing and we have sold into I think more share by insurance companies lately that we have seen, and the second area is retail. So a lot of people are revamping their retail sites, which I also was hoping, and I think going into next year we’ll see the new generation of retail online software that is very different from what we’ve seen. I’ve seen some of the demos of what our customers have done in the low end, mid tier, and also some very high end sites, and we are going to see some very, very stunning interactive sits that are going to be coming up, how people are going to do retail sales online. So, a lot of encouraging things from a vertical perspective, and I think we remain to be strong. The U.S. business is doing just so very well. I think our chance for going to next year is breaking up from just being strong in intelligence and defense and getting into the surveillance business, which is what we’re focusing on.

Robert Breza, RBC Capital Markets

Great, thank you.

Operator

Our next question comes from the line of Terry Tillman with SunTrust Humphrey Robinson.

Terry Tillman, SunTrust Robinson Humphrey

Alfred, in terms of AquaLogic that’s obviously critical to the sustainability of license growth, why not actually give us the specific number. I mean, earlier I think in the commentary or in the print it said over 20% and you had said about 20%. I don’t mean to pull hairs but folks are going to make wrong and right assumptions, why not just give us a specific number in the quarter and maybe how much growth there was sequentially?

Alfred Chuang, Founder, Chairman, CEO

I think your point is very well taken and I’ll assure that we will. But, I think at this point in time our answer is the following, because we are doing a couple of things: one is not only that we are aggressively building new products to bundle inside AquaLogic family; we did not one this quarter, repository. We also bought a company. So, while we’re going through some gyration, we within the company have to make sure that we do our allocation perfectly because once we started reporting I want to report it so accurately so your benchmark will be spot on every single time. I think historically BEA has been making that effort the whole time. I apologize for being so retentive, but I think sometimes in this world it is good to be accurate and I think we just want to be so accurate for you. It is not an intention to be elusive, to be 20 above or 20 below, I apologize for that. It is about 20, so I want to make sure that we all understand that. But over time we absolutely will, but we have to see a level maturation…at the right time. Absolutely, we’ll break it out and give you a very specific number.

Terry Tillman, SunTrust Robinson Humphrey

Okay that’s fair, but I guess just for folks that look at directional changes, and I understand there are some allocation challenges you have to go through, but can you give us a sense sequentially, was there momentum, was it growing sequentially even with some of the grayness about how had recognized it?

Alfred Chuang, Founder, Chairman, CEO

Absolutely, it’s growing. So the number grew, the percentage grew, it all grew. AquaLogic had a great quarter.

Terry Tillman, SunTrust Robinson Humphrey

Okay, and then just my last question relates to the maintenance revenue. I think it’s probably above what most all of us were looking for in the quarter, so great job on the maintenance revenue. I’m curious though, the question you always get is sustainability of that support and maintenance revenue, the Guardian program, could that be something that could sustain 20% plus growth on the maintenance revenue base? Thank you.

Alfred Chuang, Founder, Chairman, CEO

I’ve done so much study in our own company trying to get ourselves comfortable above this support revenue growth. I think after these studies and all these presentations after presentations and our own review of this program, what I think we’ve proven to ourselves is one sustainable thing – that we are going to continue to see growth. I think it’s the nature of the beast and it’s very simple. The customer becomes so reliant and so loyal to this product and the product becomes so invasive in a customer’s install base. So that means all the updates have to happen. And the kind of things fueling the fire will be the essentially Guardian. So if the customers want to do preemptive maintenance, they have to be upgrading to a lot of the patches that that releases and that is the strength to get the customers back to buy the maintenance, and I will say if anything our penetration of our maintenance space still has room to grow in many different ways, and there is a discussion about support organizations on an ongoing basis how we continue to grow that. Guardian is one of those programs that we can sell on top of mission critical support that people will be able to see what problem is coming, be able to update, prevent, and we also will be able to know the customer environment so much better than we used to be able to. So, I think all of those are vehicles that not only are assuring that we can sustain support revenue but actually try to grow it some more, which is our intent. But I think from all the studies that we have at this point in time Mark Dentinger has done more study that anyone I know of. This s a very sustainable thing on the support side and it’s a great thing to be in the enterprise software business.

Kevin Faulkner, Investor Relations

Okay, Marvin we have time for one more question.

Operator

Our last question comes from the line of John McPeake with Prudential.

John McPeake, Prudential Equity

Thank you very much. Alfred, I just have a question getting back to Adam’s original question. You mentioned you had some regional issues still, just overall coming into the fourth quarter as you entered the fourth quarter, how were the close rates relative to historic levels coming into the fourth quarter, and generally how confident are you in the pipeline? And then I have a followup.

Alfred Chuang, Founder, Chairman, CEO

John, there’s no excuse. I think in some areas of our company we didn’t execute that well. Close rate was under par, and I talked about specific areas inside Europe, and also in Japan we didn’t do as well as we really could have. But there are other areas, U.S. Federal, Nordics, China, Korea, India, the list just rings on, and their close rates are very good. The interest in our products and the pipeline in our business is very strong, and I think we’re looking at this AquaLogic phenomenon, it’s stunning and I haven’t seen one of these since WebLogic. So, I think we have made a lot of changes and some of them are overdue. I think those will make a difference going into the fourth quarter and then going into the next year.

John McPeake, Prudential Equity

Okay, so you feel good about the pipeline relative to your guidance, I guess is that fair to say?

Alfred Chuang, Founder, Chairman, CEO

Very fair to say that.

John McPeake, Prudential Equity

I don’t think you quantified it. There were some transactions that had to be put into deferred and recognized over time, and I was hoping if you could maybe quantify that for us and talk about the timing a little bit, either Mark or Alfred?

Mark Dentinger, CFO

Yeah, John, I’ll speak to it for that just a moment. What made that unique was that it was a transaction that came to us late that was a company we had done business with in a similar structure for a long time, and we had made an assumption fairly late in the game that that transaction will be presented to us in the same that it has come to us in the past. Now, when we reviewed the final agreement there actually was a slight change in the final agreement, and believe it or not slight change actually drove a different accounting result and a substantial portion – I won’t quantify the amount – but a substantial proportion of the deal had to be deferred into the future. So, the good news is that we got the transaction right, but the bad news is that because we got the late signal we couldn’t correct it in terms of the customer negotiation in the final agreement nor could we back it with anything else, and the reality is that that is a risk associated with a lot of things coming to us late in the quarter as part of the enterprise software business, but we typically have been pretty good about this and we had a late flip on this one.

John McPeake, Prudential Equity

That’s fine, without giving an exact number could you say it was a seven-figure impact in license.

Mark Dentinger, CFO

Yeah, that’s fair.

John McPeake, Prudential Equity

Okay, great, thank you.

Alfred Chuang, Founder, Chairman, CEO

Okay. I want to thank everyone for attending the BEA third quarter revenue call and I look forward to speaking to you and giving you reports, and I look forward to talk to all of you at our next earnings call.

Operator

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

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