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Executives

Kevin Faulkner – Vice President Investor Relations

Alfred S. Chuang – Founder, Chairman, Chief ExecutiveOfficer, President

Mark P. Dentinger – Executive Vice President and ChiefFinancial Officer

William M. Klein - Vice President, Business Planning andDevelopment

Analysts

Katherine Egbert – Jefferies & Co.

Derek Bingham - Goldman Sachs

Adam Holt - JPMorgan

John Walsh - Citigroup

John DiFucci – Bear, Stearns & Co.

Todd Raker - Deutsche Bank Securities

Jason Maynard - Credit Suisse

BEA Systems, Inc. (BEAS) F3Q08 Earnings Call November 15, 2007 5:00 PM ET

Operator

At this time, I would like to welcome everyone to the BEAthird quarter results conference call.  (OperatorInstructions) Mr. Faulkner, you may begin your conference.

Kevin Faulkner

Thank you, Christian.  Good afternoon, ladies and gentlemen, andthank you for joining us as we discussed BEA Systems, Inc. results for thethird quarter ended October 31, 2007, as well as results reflected in today'sSEC filings.  Please note we've postedour earnings press release, the related financial tables, and the SEC filingsthemselves on our website at bea.com.

Statements made in the course of this conference call thatare not of historical fact are forward-looking statements, including anystatements regarding the plans, goals, strategies, opportunities, andobjectives for our business.

In addition, statements that include the use of theterminology such as may, will, expects, plans, estimates, continue, predict,growth or other comparable terminology are forward-looking statements.

Forward-looking statements also include statements regardingour financial guidance, including expected revenues in our fourth-quarter andany statements that could be construed as guidance regarding our futurefinancial performance, potential improved results due to sales profit changes,potential effect of our stock option investigation, momentum and futureadoption of SOA, BEA's positioning in the SOA market, future customer resultsor implementations of our products, future product releases and any statementof assumptions underlying any of the foregoing.

Forward-looking statements are subject to risks anduncertainties that may cause actual results to differ materially from thosecontemplated by the forward-looking statements.  Such factors include those factors to bediscussed by Mr. Dentinger today and those detailed in Risk Factors in BEA'srecent SEC filings and similar disclosures in subsequent SEC filings.

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

Now, I'd like to introduce from BEA Alfred Chuang, who isFounder, Chairman, and Chief Executive Officer; Mark Dentinger, Chief FinancialOfficer; and Bill Klein, Vice President of Business Development.  Alfred and Mark will make some openingremarks, and then we will take your questions.

With that, I'm pleased to introduce and turn the call overto Alfred Chuang.  Go ahead, Alfred.

Alfred Chuang

Thanks, Kevin, and good afternoon, everyone.  Thank you very much for joining us today.  With Q3 results and today's SEC filings, wehave a lot of good news to report.  I'mproud of our team for delivering results at or above the high end of ourguidance range for the third quarter and for completing our review andrestatement, bringing us current again on our SEC filings.

Congratulations to the team for accomplishing all thisdespite significant noise in the marketplace.  We had very solid Q3 results.  Total revenue was up 11% over last year's Q3.  AquaLogic license revenue grew 31%year-over-year and is contributing to an increased record at 27% of our totallicense revenue.

Services revenue continued its strong growth, up 18% over ayear ago.  Operating cash grew 62%compared to a year ago.  Our Q3 non-GAAPoperating margin of 25% beat consensus estimates by 540 basis points.  Our Q3 non-GAAP EPS, up $0.19, beat consensusestimates by 36%.

We head into our seasonal Q4 with a solid level of businessactivities.  Based on the currentbusiness environment, we expect Q4 total revenue to be in the range of $420million to $434 million.  We expect Q4non-GAAP operating margins to be in the range of 27% to 28% compared to theconsensus estimates of 22%.

With today's filings and earnings release, we are now ableto see the very significant profitability improvements that we have made overthe last several quarters, profitability improvements that have not previouslybeen visible to Wall Street or our investors.

I will now highlight the impact that these profitabilityimprovements have had on our financial results.  At the midpoint of our Q4 guidance, our FY ’08operating margin will be 23%, 370 basis points higher than consensus estimatesof 19.3%, and our FY ’08 EPS will be $0.70 or 23% higher than First Callconsensus EPS estimates of $0.57.

These results demonstrate not only significant progress inour operating profitability they also represent a significant out performancerelative to public market expectations.  Webelieve these results reflect the success of our multiyear companywidecommitment to invest responsibly for growth while maintaining discipline in ourcost structure.

Most importantly, we believe this outperformance will materiallyimpact how investors value BEA.  What Iwould like to do is first turn the call over to Mark to give you some moredetails on the restatement and Q3 results.  Then I'll come back and talk more about ourbusiness.  Mark?

Mark Dentinger

Thank you, Alfred.  Inthe last few days, BEA made a series of SEC filings, several of which weredelinquent financial statements, which are now current.  In addition to the four Form 10-Q's since lastyear's fiscal Q1 and our Form 10-K for the year ended January 31, 2007, we alsomade other filings yesterday, which I will reference at various times in thisdiscussion.

If you have questions about the filings, please contact ourinvestor relations group or access the filings directly through BEA's websiteat bea.com or the SEC's website at sec.gov.

With our restatement complete, I will be comparing financialinformation from the current quarter to some information from prior periodsthat is being disclosed for the first time.  I encourage you to access our website, wherewe have posted a supplemental financial bridge designed to be read inconjunction with our standard quarter in review information.

This bridge will assist you in making meaningful financialcomparisons to the prior and future periods.  In order to facilitate inter-periodcomparisons, and to model our business going forward, it is helpful tounderstand the following framework about our published results.  All non-GAAP presentations of our financialresults are derived directly from our GAAP financials.

Our standard non-GAAP adjustments are based on theconventions of most businesses in our industry and exclude the following fromGAAP earnings, FAS 123R expenses and stock option issuances and standarddiscounts on employee stock purchase plan sales, in-process R&D andamortization of deferred compensation and other intangibles associated withacquisitions, and any income or expense items which are not expected to berecurring, such as gains or losses on impairment or disposal of assets,restructurings and unusual tax items.

Additionally, three other phenomena, restatement of ourfinancials, 409A tax and advisor fees associated with recent activities areaffecting our current and recent GAAP earnings, which we do not expect to bepart of our long-term cost structure.  Therefore,our non-GAAP earnings also exclude the following expenses.

Any residual restatement charges or credits impacting ourreported results for the last three fiscal years, including fiscal 2008;third-party expenses associated with completing the stock option investigationand restatement, non-cash charges for modifying stock awards and bonuses paidto employees in Q4 of fiscal 2007, both of which were designed to mitigate theimpact on our employees from not being able to sell their stock during therestatement period.

Advisory and legal fees arising from Carl Icahn'sshareholder litigation and activist activities, as well as Oracle's offer toacquire BEA, and expenses accrued and paid by BEA to federal and state taxagencies to remedy our current former employees' exposure to 409A taxes.

With this framework in mind, let me start by discussing ournon-GAAP Q3 income statement results.  Revenue for the quarter was $384.4 milliondollars, up 11% year-over-year.  Licenserevenue was $134.8 million dollars or 35% of total revenue, and servicesrevenue was $249.6 million dollars or 65% of total revenue.

Licenses revenue decreased by 1% from last year's Q3 andservices revenue increased 18%.  Thelargest component of services revenue, customer support, was $194.8 milliondollars, a 17% increase compared to last year's Q3.

Consulting and education revenues were $54.8 million dollarsin Q3, up 23% from last year.  Geographically, the Americasregion generated 50% of our Q3 revenue, which is down 5 percentage points fromlast year's Q3.

Internationally, our EMEA business contributed 33% of totalrevenues, a 3-percentage point improvement from a year ago, and Asia-Pacificwas 17% of revenues, also a 2-point improvement from last year.

By product, the AquaLogic family contributed 27% of our Q3license revenue versus 20% in Q3 of last year. WebLogic and Tuxedo families contributed 73% of our license revenue inQ3 versus 80% in Q3 of last year.  Q3total license transaction count of 2,506 increased approximately 2% from lastyear.  Our average transaction sizedecreased by approximately 3%.

For Q3, industry vertical performance was as follows.  Telecommunications was 20% of license revenue. Government was 18%.  Banking and finance was 15%, and services were14%.  Other verticals were individuallyless than 10% of license revenues for the quarter.

Now let me address costs and expenses.  Non-GAAP cost of licenses was 6.6% of licenserevenue for Q3, up from 5% in Q3 of last year, principally for third-partyroyalties and certain Q3 transactions.  Costof services was 29% of services revenue compared to 30% in Q3 of last year.  Most of the services margin improvementresulted from higher margins in our professional service business.

Total operating expenses for Q3 were $207.6 million dollars or54% of total revenue compared with $204.5 dollars million in Q3 of last year or59% of total revenue.  Sales andmarketing expense was $126.8 million dollars or 33% of total revenue in Q3,compared with $123.7 million dollars or 36% last year.

R&D expense was 14% of revenue in Q3, compared to 15% ofrevenue in Q3 of last year.  G&Aexpenses, at 7% of revenue in Q3, were down from 8% of revenue last year.

Our Q3 non-GAAP operating profit was $96.2 million dollars,compared to $72.5 million dollars a year ago.  Expressed as a percentage of Q3 non-GAAPoperating margin it was 25%, up from 21% a year ago.  Our non-GAAP other income and expense, or OIE,increased to $13.6 million dollars in Q3 versus $9.5 million in Q3 of lastyear.  The OIE improvement was largelythe result of reduced interest expense on our line-of-credit borrowings.

Our non-GAAP tax rate of 28.1% of pre-tax non-GAAP income inQ3 compared to 27.6% in Q3 of last year.  We expect our intermediate-term non-GAAP taxrate to approximate 27% to 29% based on current earnings distribution, but thequarterly rate can fluctuate based upon specific items that arise each period.  After making the previously mentioned non-GAAPadjustments, third-quarter net income on a non-GAAP basis was $0.19 per shareor $78.9 million dollars.

Fully diluted weighted average shares outstanding, used inour Q3 EPS calculation was 415.6 million.  The share number used in last year's Q3 EPScalculation was 415.5.

Our Q3 results would have been approximately 4% lower intotal revenue, 3% lower in cost of revenue and 3% lower in operating expensesif we had translated current quarter at currency exchange rates in effect lastyear.

We were also profitable on a GAAP basis during Q3, recordingfully diluted EPS of $0.13 a share compared to $0.08 per share in last year'sQ3.  As part of our GAAP earnings in Q3,we absorbed the following nonstandard pre-tax charges, which are shown in thesupplement to our quarterly review publication.

$6.1 million dollars for external expenses associated withthe options investigation and restatement; non-cash charges of about $2.3million dollars associated with modifying stock option awards for departingemployees and employees with expiring options.

Severance charges of approximately $7 million dollars associatedwith a reduction in force early in Q3, which I alluded to on last quarter'scall; and advisory and legal expenses of about $1.4 million dollars associatedwith addressing Icahn and Oracle defense-related activities.

As I alluded to earlier, concurrent with the posting of ourdelinquent SEC filings, we also announced a tender offer to our employees whoare still holding stock options affected by IRS section 409A.

Under the tender offer, BEA will pay impacted employees toraise the strike price of their affected options, thereby removing the 409Aproblem.  We expect to make payments ofapproximately $10.1 million dollars in Q4 under this offer, but we also expectto realize most if not all of these payments back in the form of higherexercise prices on these shares.

Now, let me address our balance sheet.  We ended the quarter with total cash andinvestments of about $1.3 billion dollars, and we generated $87 million dollarsin cash flow from operations during Q3.  Inthe same quarter last year, our operating cash flow was $54 million dollars.

The year-over-year 62% operating cash flow improvement wasthe result of our improved operating performance, combined with better balance sheetleverage.

DSO at the end of Q3 was 70 days compared with 71 days atthe end of Q3 of last year.  Our deferredrevenue balance was $389 million dollars at the end of Q3 compared with $338million dollars at the end of Q3 last year.

Total headcount decreased by 169 in Q3, and we exited the quarterwith 4,119 employees.  We expect that ouroverall headcount will remain approximately flat during Q4, although we willcontinue to realign resources towards the growth areas of our business.

I will now discuss our guidance for Q4.  The following comments and guidance areforward-looking statements, as are any other comments about our futurefinancial and product performance.  Youshould review our Form 10-K for the year ended January 31, 2007 and our Form 10-Q for the quarter endedJuly 31, 2007, both ofwhich contain important risk factors that could cause actual results to differfrom those contained in these forward-looking statements.

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

We also face uncertainty concerning our future, given certaininvestors' call to auction the company, the recent unsolicited takeover offerfrom Oracle, and our board of directors' stated willingness to negotiate thesale of the company at $21 per share.

Our comments on guidance are based on current businessconditions and information we have as of today's call, and we caution investorsthat numerous factors, such as the risk factors discussed above, could causebusiness conditions and customer buying patterns to change significantly.

We assume no obligation, however, to update our guidance orcomments on future performance.  If we doupdate our comments and guidance, it is BEA's policy to do so throughappropriate public disclosure.

In determining guidance, we are not assuming any significantchange in the global economic climate or IT spending levels in the near term,nor are we projecting possible impacts on our business, which might result fromthe recent volatility in the U.S.mortgage-backed securities markets.

Based on these factors and current business conditions, weanticipate that revenues in the fourth quarter of our fiscal 2008 will bewithin a range of $420 million to $434 million dollars, and that the licensecomponent will be 39% to 41% of total revenue.

Additionally, we expect our non-GAAP operating margins to bewithin a range of 27% to 28%.  Finally,based on current earnings distribution estimates, we are modeling a 28%non-GAAP tax rate for Q4.

If our current stock price is maintained, weighted-averageshares outstanding are expected to increase by about 6 million shares in Q4,assuming there are no stock buybacks or other capital activities.

We also expect to incur additional nonstandard GAAP expensesin Q4 for final charges for third-party fees associated with completing our restatement;non-cash charges resulting from the final modifications of expiring stockoption awards, which could not be sold until the restatement was completed.

Approximately $12.8 million dollars in cash expensesassociated with final remedy of our current and former employees' exposure to409A taxes; and approximately $6 million to $7 million in expenses for advisoryfees associated with the unsolicited offer from Oracle and related activities.  These advisory fees will likely continue intonext year.

Finally, I would direct your attention to a one-timereclassification in our cash flow statement for Q4 of ’07.  We previously disclosed $95 million dollars incash flow from operations for that quarter.  As a result of adopting FAS 123(NYSE:R) in fiscal2007 and the fact that we drew down valuation reserves against deferred taxassets for the first time in ’07 during Q4 ’07.

There is a one-time reclassification of $99 million dollars outof operating cash flow and into cash generated from financing activities.  In essence, this reclassification representsthe cumulative catch-up for periods prior to February 1, 2006 of recording whatwas the FAS 123(R) excess tax benefits amounts that would have been in earlierperiods.  Thus, the revised Q4 ’07 cash flowfrom operations number is now a negative $3 million dollars.

We caution investors against using this number for trendingor comparative purposes, because this cumulative catch-up concept will not bepresent in other quarters.  For modelingpurposes, the $95 million dollars in positive cash flow we originally reportedis probably a more accurate observation.

I would also like to point out one other cash flowphenomenon likely to be present in Q4 of ’08.  Part of our year-to-date cash flow improvementis because our employees had not been selling stock options during therestatement process, and therefore, we haven't been recording the tax benefitfrom these option sales.

Notwithstanding the one-time catch-up in Q4 of ’07, theaverage quarterly benefit of this reclassification is about $3 million dollars. With our restatement now complete, weanticipate some pent-up demand for our employees to exercise and sell theiroptions during Q4.  And accordingly, thetax benefit reclassification will likely be considerably larger than normalnext quarter.

As a concluding thought, I recognize we have transmitted alot of data over the last 24 hours, and I would like to summarize thisdiscussion by directing you to comments I've made at several investor presentationsover the last year or so.

In those presentations, I indicated that BEA was currentlymanaging in a financial framework designed to generate 200 to 400 basis pointsof non-GAAP operating margin improvement in periods where we grow total revenueby 10% to 15%.

What is now visible is that if we can deliver a Q4performance at the midpoint of our guidance range, we will actually achieve a200 basis point improvement in operating margins in fiscal ’08 on a total topline growth of about 8.5%.  With our FY ’08margin improvement trend now visible, investors and analysts have a betterunderstanding of our margin expansion potential as we look forward to fiscal2009.

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

Alfred Chuang

Thanks Mark.  So nowlet me give some of my thoughts on our Q3 results.  We have a significant amount of positive newsand some ongoing areas of continuous improvement.  Asia-Pacific continued its stellarperformance, with 23% year-over-year growth in license order.

Japancontinued its momentum for its third consecutive quarter.  Performance in Asia-Pacific was balanced, withnoteworthy performance in Japan, China, and ASEAN.  The team is doing a great job drivingAquaLogic adoption in the region, both with the end-user customer and alsopartners like NEC, CTC and many others.

The APAC pipeline continues to also look very strong.  EMEA license order grew by more than 10%.  The United Kingdom performed very well, and webelieve we are on track for continued improvement in the quarters to come.  In addition to the U.K., EMEA results aredriven by solid performance in France, Germany, and the Nordics.

The team is also driving AquaLogic adoption in the region.  Go-to-market efforts with our partner, VMwarein the virtualization marketplace, which began in the U.S. several months agoand is now expanding to EMEA.  The EMEApipeline looks very strong.

Our solid overall results were achieved despite achallenging quarter in the Americas in some areas.  The business environment in the Americaswas a challenge for BEA, and this was also for many other IT companies who havereported their results recently.

We do, however, have a strong American pipeline andanticipate a solid Q4 performance.  InQ3, our total revenue growth returned to the double-digit range that is tied toour margin improvement growth.  Weachieved that by focusing on our customers' success and increasing penetrationof our products in our customers' product environment.

We continue to focus on improving our license revenueperformance, but maintenance revenue is just as important in measuring oursuccess.  Let me be very specific.  Our typical customer contracts are designed tomaximize total revenue, profitability, and cash flow over the life of thetransaction.

To that end, we regularly structure customer contracts toincrease the net present value of the order, in terms of total revenue, cashflow, and profitability.  That kind ofstructuring over the last few years has caused license revenue to become a lessmeaningful predictor of total revenue growth.

For the same reason, our license growth rate under-stay ourgrowth in customer penetration, which we view as a very key driver of totallong-term revenue and profitability for the company.  Growth in total revenue, combined withincreasing operating margins, drove an even faster increase in EPS.

Margin improvement has been a focus area that we havedelivered in the past several quarters.  Atthe same time, we remain committed to investing responsibly for growth.  So when you value BEA, it's very important toconsider our growth prospects.

Our investments are focused on three main drivers ofprofitable growth.  First, it is ourgrowing and emerging product areas such as SOA, virtualization and thetriple-play communications area.  Specifically,growth initiatives like AquaLogic have been very, very successful.

We believe opportunities that have significant potential,like Project Genesis for the Enterprise Web 2.0 features and dynamic businessapplications as well as WebLogic Virtualization and the Communication Platformare on the verge of demonstrating huge success.

Second is our focus on investing for growth in emergingeconomies like China,India, Korea,and ASEAN.  We have already established avery strong people, employee presence, partnerships, and customer base inbuilding a great brand in all of these territories, and we are leaders in allof these markets.

These areas have provided steady double-digit license growthand pipeline continues to look very strong for these regions.  And we continue to invest in people andrelationships and specific products in those areas to fuel the next stage ofgrowth for this region.

Third is our sales force and channel program, to improve ourproduct distribution.  Our sales forceexecution programs have improved our productivity and visibility andcontributed to our overall ability to leverage the cost base and driveprofitable growth.

With additional improvement targeted in the Americas,we can make further progress.  We willcontinue to invest in these programs next year and also expand our channelprogram.  We believe our focus in theseall three areas has contributed to meaningful and long-term growth prospectsfor BEA.

So let me give you some additional details on BEA's growthopportunity in the new product categories.  AquaLogic consists of several products thatcan be purchased individually or as a suite.  When we introduced AquaLogic, we predictedthat customers would start with one or two products and add new products overtime as their SOA environments become broader, more robust, and more mature.

That is exactly what is happening.  Our penetration into the SOA marketplacestarted with our portal products then it expanded into the service bus.  Last year, our BPM product doubledsequentially every quarter, and BPM revenue through the first three quarters ofthis year has doubled compared to last year.

As we mentioned last quarter, the next SOA category to gainmomentum was our governance products, which have grown about 130% compared tothe first three quarters of last year.  InQ3, AquaLogic User Interaction had its best quarter ever, and is poised forgrowth with the introduction of our Pages, Ensembles, and Pathways products.

Project Genesis will support Enterprise Web 2.0 capabilitiesand support the next generation of dynamic business applications.  We've succeeded in selling our SOA products toour existing customer base and also expanding into WebSphere accounts and alsoto Microsoft .NET accounts.

On the WebLogic front, WebLogic Communication Platform hadits best quarter ever.  WebLogicCommunication Platform continues to create opportunities to sell AquaLogic andWebLogic into the network side of our Telco customers and has a strong pipelinefor Q4.

WebLogic Real Time and Advanced Server also had its bestquarter ever.  Our new virtualizationproducts have begun to gain reference customers.  The opportunity to sell virtualizationupgrades to our WebLogic installed base represents a huge opportunity for us.  We have a strong go-to-market partnership withVMware to address this opportunity.

Now, let's talk about what all this means to ourshareholders.  Our board has concludedthat the recent unsolicited to offer to purchase BEA significantly undervaluedthe company.  This conclusion was basedin part on the growth prospects I just outlined for you.

And was also based in part on our financial performance,which due to our delayed SEC filings, was not visible to you over the last fivequarters and which significantly exceeded the financial performance estimatedby research analysts over the same period.

Current First Call average FY ‘08 EPS estimates of $0.57 arematerially understated, which caused a significant valuation disconnect to ouractual performance.  Specifically, if wehit the midpoint of our Q4 guidance, actual EPS for FY ‘08 is now expected tobe $0.70 per share, 23% higher than the First Call average estimates.  Those figures imply materially higher EPSlevels and materially higher EPS growth rates that we have previously beenvisible.

Over the last five years, our non-GAAP EPS has grown at acompound annual growth rate of nearly 20% and that growth rate has acceleratedin the last two years.  In fact,projected EPS for this year is now higher than the First Call average EPSestimates for the next year.

Our EPS growth, the disconnect between our actual growth andStreet estimates and the growth opportunity for our new products are majorconsiderations in how management and the board value BEA.

Before I open up for questions, I would like to summarize.  Here's what I see as key themes for thequarter and our financial results.

First, we delivered a solid quarter despite thedistractions, and the license revenue trend-line is heading in the right direction. We have a solid pipeline heading intoour seasonally Q4, and we expect to return to license revenue growth in Q4.

Second, 30% AquaLogic growth demonstrates that ourproduct-driven growth strategy is working, and we expect meaningfulcontribution next year from additional categories like WebLogic Virtualization,WebLogic Real Time and our Communication Platform product.

Third, we have significantly improved operating margins andEPS, more than anyone had estimated, that were reflecting in all the analystreports, and more than consensus forecasts for the next year.  At the midpoint of our guidance, we will beatcurrent FY ‘08 EPS estimates by 23%.  Wewill beat next year's estimates this year.

We believe in our strategy and future prospects forincreasing shareholder value and our ability to execute.  With that said, we continue to explore ways tomaximize shareholder value, and that including the possible sale of the company. In the meantime, the company is focusedon executing our growth strategy and operating model to drive shareholdervalue.

With that, I would like to turn the call back over to Kevinand open up for questions.  Kevin?

Kevin Faulkner

Thanks.  So Christian,you can assemble the question-and-answer queue.

Question-and-AnswerSession

Operator

(Operator Instructions)  Our first question comes from Katherine Egbertwith Jefferies.

Katherine Egbert -Jefferies

Hi.  Good eveningAlfred and Mark.  Your licenseperformance this quarter was better than your expectations going in.  Can you talk about why that was?  Then also, were there any prepaid licensesthat came out of deferred revenue into revenue this quarter?

Mark Dentinger

Yes.  With respect tothe prepaid license portion of the question, there is a de minimis amount,nothing more than what we would have normally had coming into the quarter.  And with respect to the license performance inthe quarter, its estimate Europe had a very solid quarter.  Asia, as usual, knocked the ball out of the park. And we fought it through in theAmericas, which are a tougher environment, but we were very pleased with theoutcome.

Katherine Egbert -Jefferies

Did Virtualization Edition add any licenses this quarter?

Alfred Chuang

Katherine hi.  This isAlfred.  Yes, it did.  We actually did several deals, but it wasstill small, with some just we have very little timing issues with the productin the quarter.  As you will recall, weactually introduced the product actually at BEAWorld in the midstream of thequarter itself.  But the prospects are stillvery good.  The interest level of thisproduct is extremely high.

Katherine Egbert -Jefferies

Okay.  And then, lastone.  Can you tell us specifically howyou came up with $21 a share fair value?

Alfred Chuang

Well, I think several things, Katherine.  One, now that we're up to date on all of ourfilings, I think all of our investors, also our financial analysts now, cancome up and be able to see the significant improvement in profitability and seehow all this will be able to translate into valuation.  We did all the valuation very carefullyalongside with our advisors, and looking at all the parameters.

I also will ask Bill Klein to answer this question.

Bill Klein

Sure, Katherine, this is Bill.  And basically, we looked at the classicalkinds of valuation techniques, trailing forward P/E multiples, comparabledeals, DCF, synergy analysis.  So, it'spretty typical, standard stuff and the numbers kind of triangulated all in apretty common point.

The outlier is probably the synergy analysis, which I'm sureyou seen and read supports numbers in the high 20's.

Katherine Egbert -Jefferies

Okay.  Is the synergyanalysis specific to Oracle?

Bill Klein

The one I'm referring to is.

Katherine Egbert -Jefferies

Okay.  Thanks Bill.

Bill Klein

Thanks Katherine.

Operator

Our next question comes from the line of Sarah Friar withGoldman Sachs.

Derek Bingham -Goldman Sachs

Hi everyone.  It'sDerek for Sarah.  On the margin targets,as we think about next year, I just wanted to make sure I clarify.  You've done some tightening up, obviously, andhave put up some significantly bigger margins.

I just want to make sure we understand.  Is that something that you can do more ofgoing into next year?  Or does that 200to 400 basis point formula continue to hold, based on that 10% to 15% revenuegrowth for next year?

Mark Dentinger

Yes, Derek.  The 200to 400 basis point framework is still operating as we go into next year and westill believe that that's the relevant framework in the 10% to 15% totallicense or total revenue growth scenario.

But as you saw this year, we can do better in lower revenuegrowth scenarios and again, we will tend to our mindset going into next yearwill be to make sure that we're investing in the higher growth areas of thebusiness, but being mindful of the proper trade-off between cost control andinvesting for our future.

So, I think that the framework is still valid and active,and there always exists a possibility we could do better.

Derek Bingham -Goldman Sachs

Could you give us just a little bit more color?  You've had margins, I guess, at a prettyconsistent rate, kind of closer to 20% for a long time.  Just some more specifics on where thetightening came from?

Mark Dentinger

Yes.  You can see ourG&A expenses right now at 7% are probably better than competitive acrossthe industry.  So, we're doing it fairlywell and we are real proud of the team of getting us through this year at thatlevel in view of the stock option investigation and restatement.  But we are also getting more efficiency out ofthe sales line as well.

But at this point, the biggest indicator is that the scaleis working in our favor and we think we can continue to leverage the businessat this point, and can continue to demonstrate the margin improvement we justshowed you.

Derek Bingham - GoldmanSachs

Okay.  Perfect.  And just one more if I can, could you justgive a little bit more color specifically on what you're seeing from verticalsin the United States in terms of their ability to spend, currently?

Alfred Chuang

Yes, Derek, hi, this is Alfred.  In Q3, we saw a reasonably good performance, Ithink, around the globe.  I think the Americaswe saw, I think, the usual softness that our other relating companies areseeing in the financial services sector.  We have slipped a few large deals into Q4.  Some of those we have closed.

So, we are not seeing any outliers that no, other people arenot seeing.  I think our Telco sector hasperformed very well in the quarter, and some of the other areas ofmanufacturing in retail and in government.  So, we do expect, I think some of those aregoing to continue to do well going into Q4.

Derek Bingham -Goldman Sachs

Got it.  Thank youvery much.  Congratulations.

Alfred Chuang

Thanks Derek, I appreciate.

Operator

Our next question comes from the line of Adam Holt withJPMorgan.  Please go ahead with yourquestion.

Adam Holt - JPMorgan

Hi, sorry about that.  I got disconnected there earlier not sure whatwas happening, can you hear me now.

Alfred Chuang

Yes.  Adam I can hearyou well.  Thanks.

Adam Holt - JPMorgan

Okay.  Just maybe afollow-up question on the margin out performance, it looked like direct sales weredown about 8% on a year-on-year basis.

Is that an area where you think you're going to be able toget more leverage going forward or are we in a situation where you've basicallygotten to your core team and you're going to start to rebuild from currentlevels in sales?

Alfred Chuang

Yes, Adam, great question.  What we're seeing are several things.  Number one is we have invested long and hardin our channel strategy, so between our VARS and our VATS, we had a greatquarter.

So clearly, I think on similar indirect channel kick in forsome of the products that are really indicative to be sold through the channel,if that strategy clearly is working.  So,we clearly like that, and that has helped us in terms of rebalancing some ofour costs from the direct side and the indirect side.

We also, obviously, are in the ongoing process of going intothe next fiscal year, looking at the profile of how we want to invest in ourdirect sales selling action.  You seeplaces like Asia, where we are growing very, very fast.

We have a very strong indirect strategy there, where we willbe placing a lot more effort in terms of supporting the indirect channel andgrowing into additional processes into China,for example.

Other countries in ASEAN, like Thailand,the Philippinesand areas like that, we will continue to grow those in terms of indirectlysupporting the channel, penetrating those marketplaces.

We will selectively and be aggressive in terms of ourinvestment in the direct sales force in the Americasgoing into next year.  So, I wouldn'tread too much into the different reload balancing acts, while we're goingthrough the channel at this point in time.

We'll have a whole lot more to report through Q4 and goinginto Q1, what our plans would be in terms of significantly growing our channelefforts.

Adam Holt - JPMorgan

And if I could just follow-up on your comment about theAmericas and again, I apologize if I missed this earlier.  There was some issue with the lines.  But the Americas were down a little bit on ayear-on-year basis in the quarter.  Itsounds like that's not an area where you're going to be investing aggressivelyon the sales side.

How do you think about the growth potential in North America, say, over the next 12 to 18 months?

Alfred Chuang

I think the opportunity is strong.  As you see that we are coming out of Q1, wehave a lot of work to do in terms of improving our sales execution.  We saw, I think, a notable sales executionimprovement in the quarter and obviously, we will continue to invest in theAmericas.

I think nothing that we have done in terms of the lastquarter itself will be indicative of what we're going to do in the Americas. We are seeing a very strong Q4 pipelinein the Americas itself.  They are some ofthe new verticals we're getting into we are seeing success with some of our newproduct lines.  So, we will continue toinvest into those.

Adam Holt - JPMorgan

And just my last question, you have got a relatively largebuyback in place.  What are the plans onthe buyback going forward?  Thank you.

Alfred Chuang

Yes.  Thank you verymuch.  We do have a board approved $622million dollar authorized share repurchase plan in place.  Today, we are not considering, right now torepurchase those shares because of our ongoing exploration of ways to maximizeshareholder value.

Some of those activities will prohibit us from going intothe market, so we will be not doing that until, I think, those are clear.  Thank you, next question.

Operator

Our next question comes from the line of John Walsh.  Please go ahead with your question.

John Walsh -Citigroup

Good afternoon.  Juston that last point, would it be likely to be then, after the shareholdermeeting, buyback, and exploration activity?

Alfred Chuang

Yes, John.  Actually,those will be independent of the shareholder meeting.  Some of those activities that we are engagedinto, really, I think we'll just be prohibited from trading in the marketplace. That's really the reason.  It's much more independent than theshareholder meeting dates.

John Walsh -Citigroup

Okay.  And then, Mark,in the quarter, there's a number of adjustments made.  Maybe walk us through, specifically, deferredcompensation and the restatement adjustment effort?

Mark Dentinger

John, you broke up just a little bit towards the end.  You were asking about…

John Walsh - Citigroup

Two specific lines, the acquisition related deferredcompensation expense, why that adjustment and income adjustment?

Mark Dentinger

I heard the first part of it, which was theacquisition-related deferred compensation adjustment.  That happens every quarter, John.  That's standard and returning, and is actuallya standard GAAP to non-GAAP adjustment that gets reported by most companies inour industry.

And that's the deferred compensation that gets recorded whenyou do an acquisition related to stock incentives to employees that you'rebringing onto your books.  And wetypically sweep those out, and it's analogous to the FAS 123(R) sweep that wealso do.

I couldn't understand your second …

John Walsh -Citigroup

Yes, the restatement adjustment.

Mark Dentinger

Yes, the restatement adjustment, so there are twocategories.  One are the costs associatedwith actually finishing the restatement, and there's also some continuingadjustments that will linger out and basically will probably wrap up by the endof Q4 associated with employment taxes and things like that, that are spillingover from the restatement period themselves.

So, those are the two buckets and categories.

John Walsh -Citigroup

Are they cash-related or not?

Mark Dentinger

In the employment tax case, there may be a little bit ofcash there, but they are fairly small.  In the case of the expenses associated withcompleting the restatement, they would be cash-related.

John Walsh -Citigroup

And then just one product question, WLCP had its bestquarter, Alfred.  Will that be broken outwhen it reaches 10% of license revenue as AquaLogic was, expect that by the endof next year?

Alfred Chuang

Yes, John.  Weactually have several plans.  One is wewill soon be announcing actually, we're going to be forming a unit in the companyto focus in this marketplace, as we clearly are seeing that the product ismaturing.

We have embedded enormous amount of that technology ispractically in every single Telco equipment providers.  It is time to see some of those deals get soldthrough into the end-user space.  And Ithink the revenue generation picture is just very positive.

And we will obviously as time continues and we pick upcontinue to see this momentum, we probably will be breaking out and show youwhat we're doing in the area.  So, moreto come in the area, very positive.

We are very, very pleased with all the effort that put intothis product line and securing ourselves in just a very strong place on thenetwork side in the Telcos.

John Walsh -Citigroup

Okay.  Thanks.

Alfred Chuang

Thank you.

Operator

And our next question comes from the line of John DiFucciwith Bear Stearns.

John DiFucci - BearStearns

Thanks.  With yourfilings, we can see now that your cost structure was reduced here, at least onthe income statement.  But really, wewere able to see, you were telling us what the operating cash flow was, so wehad some idea what was going on there.

But can you explain your thinking there in regards to whatyou think your opportunity is going forward with reducing costs, and especiallywhat your thinking is going forward?

Mark Dentinger

Yes, John.  Thestarting point is that we believe we're approaching an inflection point inleverage and our ability to generate more revenue basically within the samecost envelope.  And although that doesn'tpreclude us from investing in the high growth areas of the business, I thinkwe're just being smarter where we invest the dollars with respect to the returnwe're getting on the top-line.

And the other thing is that the maintenance growth business,as you know, is extremely highly leveraged.  As long as we continue to grow that asaggressively as we are and we believe we grow that faster than our competitorsin the industry.  As long as that growsas quickly as it does, operating leverage is always a possibility.

John DiFucci - BearStearns

Okay.  Okay.  And Mark, just to go back to another question,I think, John had asked it earlier, it does seem like there's a lot of GAAPexpenses that are newly excluded from your non-GAAP results.  Even the advisory fees, I can sort ofunderstand that, but you say it's going to be recurring going forward.

When do some of these things just sort of become recurringexpenses?  Other companies have similartype expenses that they let us know what they are, but they don't exclude themfrom non-GAAP results.

Mark Dentinger

Yes, the advisory fees are an interesting area, becausewe're in a particular, a unique situation of having both a hostile bid for the companyand a shareholder activism, a highly profiled shareholder activismcircumstances.

So, we are absorbing these, and we don't believe that bothof these circumstances can continue for the long run.  So, as I indicated, I do believe that theywill probably continue into early next year at least, but while they are here,we believe it's not part of our permanent cost structure.

The other two sets of the, let's call it the specialexempted items coming out of the non-GAAP to non-GAAP bridge are relatedessentially around all of the restatement efforts and cleaning up mattersrelated to the restatement.

Those should fade away, in large part, after about Q4, andyou will see a far more conventional profile as we enter next year.

John DiFucci - BearStearns

Okay.  And just onelast question, I guess for Bill, since you sort of brought it up.  Don't you think when people are looking atvaluation, they consider all those multiples you threw out there, but cash flowis really what is pre-eminent on most serious investors or even anyone lookingto buy the stock or the company?

So, we've actually had all that already.  So is that something that you believe, basedon cash flow, is that where that $21 came from?  I guess that's the question.

Bill Klein

Well, like I said, cash flow is one of the models we used.  In addition to that, we looked at both forwardand trailing P/E multiples, growth rates and …

John DiFucci - BearStearns

But don't you think those trailing, those P/E multiples arereally just used as a proxy for cash flow and then that's a sort of the thingthat people are going to focus on?

Bill Klein

Well, I think the point is the earnings that we were unableto report were significantly higher than what was publicly available in themarket.

John DiFucci - BearStearns

But you were able to report or at least give us theoperating cash flow number.

Bill Klein

Right, but at the same time, we reported earnings that wereover 500 basis points higher than what the Street consensus numbers were.  So I think that did have a pretty significantimpact in a lot of people's models.

John DiFucci - BearStearns

Okay.  Okay.  Thanks a lot.

Operator

Our next question comes from the line of Todd Raker withDeutsche Bank.

Todd Raker - DeutscheBank

Hey, guys few question.  First, I was hopeful you could give us someinsight, when you talk about exploring shareholder value on that path, whatexactly are you guys doing on a, I mean the sale of the company?

Bill Klein

Yeah, this is Bill again.  I think, for obvious reasons, we're not goingto go into the details or comment on what process we are looking at or who wemight be talking to.  But I think it'ssafe to say that we're actively exploring ways to maximize shareholder valueand we're using our time wisely.

Todd Raker - DeutscheBank

Okay.  And then when Ilook out to at the year, you guys have talked about the focus more on themaintenance side and the maintenance growth there being important.  But, that we should expect license growth on ayear-over-year basis next year or in a growth profile next year?

Alfred Chuang

Yes, Todd.  Hi, thisis Alfred.  We obviously do.  If you look at the trend line of a year ago, ayear ago we had 17% growth on the top-line, 12% growth on the license.  We had poor performance in Q1, and you can seewe had decent performance in Q2.

We had quite an improvement in Q3 and if we hit the midpointof our guidance going into Q4, we will see license revenue growth.  If that's the trajectory, you can see that wewere expecting license revenue to grow next year.  That’s clearly what we're working towardsinside the company.

Todd Raker - DeutscheBank

Okay.  And then insome of your comments, Alfred, you have talked about your ability to monetizemaintenance, customer base and in fact, I think, you said you are better atthat that your peers.  What is it that'sdriving that momentum and that gives you the leverage on the maintenance?

What is so differentiated about BEA versus the rest of thesoftware universe?

Alfred Chuang

Well, it's a great question because, I tell you, this showshow sticky our technology is in the customer.  You look at BEA, how we sell our technologies,we have a very large, million-plus application developers that follow ourtechnology very strongly, which is why we're investing so heavily in R&D.

And that penetration goes two ways, one is more projects arebeing developed in these organizations.  Particularlythey are going through this web modernization and a lot of these new activitiesthat we talked about in collaboration and many of these new things, Web 2.0,people building new projects, allowing us to be selling further into thoseaccounts.

The other things is, once they buy a license from us and goto production, then they start consuming more CPU and more instances of CPUalong the way and that gives us a leverage in an existing account that we cango broader and broader and that also further drives, obviously, the maintenancerevenue, giving us more leverage to continue to do new deals with thecustomers.  Those are very typical thingsof how we actually sell into those accounts.

If you look at our total installed base, it is still growingat a pretty phenomenal rate, 10% plus in the year, in our total installed basesize.  So it is not a small base.  Our current base is like 17,500 customers, andit's growing very, very fast.

So I think all of that in those multitudes of ways is givingus the leverage to continue to be growing revenue in multi-facet, not only justlicense, but also maintenance and cash and other things in the account as well.

Todd Raker - DeutscheBank

Okay.  Thanks guys.

Alfred Chuang

Thank you very much.  Justin we’ll take one more question.

Operator

Our last question comes from the line of Jason Maynard withCredit Suisse.

Jason Maynard -Credit Suisse

I just wanted to follow up to the last question aroundlicense revenue growth and just within the 10% to 14% framework that youoffered, what is the sort of the core assumption that you are assuming forlicense revenue?

Bill Klein

Well, the 10% to 15% total growth scenario, Jason,encompasses what is right now a linear function on basically the supportbusiness and the balance of it turns out to be license and so, if you can seeright now, we are still getting teens-level return on the support business.  And the purpose of putting that model out isto show we can still get operating leverage in relatively low license revenuegrowth scenarios.

In this year, even in a flat license scenario, we can stillachieve leverage.  So the purpose ofputting that model out is to say our current framework is very leveragable,even in modest license or zero license revenue growth environments.

Jason Maynard -Credit Suisse

I guess one of the challenges that a lot of softwarecompanies have faced and this is more of a historical comment.  When they are around the $1 billion, $1.5billion mark, it’s been difficult sometimes to really push those margins to28%, 30% level without more sustained license revenue because, obviously,license revenue being the catalyst to add more subscribers and maintenancerevenue.

I'm just trying to understand what's in the cost structure,then, that you see will give you that additional leverage or pull to grow themargins a couple of hundred basis points?

Bill Klein

The real difference in our model Jason is that the supportstructure is incredibly sticky.  AsAlfred alluded to earlier, our renewal rates are phenomenal and our pricing disciplinearound support is phenomenal and those two phenomena are a testament to thetechnology.

Once our customers get on the technology, they are veryloyal.  They very, very rarely go away.  Getting then on there, that makes ourcircumstances probably not comparable to all of the other comparables that youlook at.  That phenomenon has beenpresent for several years, and there's no reason to believe that's going tochange.

Jason Maynard -Credit Suisse

Okay.  Thanks for thequestion.

Alfred Chuang

Thank you everyone.  Giventhe technical difficulties, I do want to give you a quick summary of where weare for the quarter.

In Q3, our revenues were $384.4 million, up 11% from a yearago,  license fee of $134.8 million.  Service revenue was $249.6 million, up 18%year-to-year.  Support revenue was $194.8million, up 17% year-to-year.

Deferred revenue was $388.6 million, up 15% year-to-year.  GAAP operating profit was $64.3 million, up70% from a year ago.  GAAP operatingmargin was 16.7%, up from 10.8% a year ago.  Our GAAP net income of $56 million is up 59%from a year ago.

Our GAAP diluted net income per share of $0.13 a share wasup from $0.08 a share a year ago.  Cashflow from operations for the quarter was $87 million, up 61% from a year ago.  Our cash balance is now $1.3 billion.  Our earnings per share growth were 43% year toyear, and EPS exceeds First Call by 23% if we hit the midpoint of our margin,and this beats next year's estimate this year.

With that, I want to thank you for your time, and Iapologize for the technical difficulties.  I look forward to speaking to you through thequarter and also in our next earnings call.  Thank you very much.

Operator

Ladies and gentlemen, this does conclude today's conferencecall.  You may now disconnect.

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Source: BEA Systems F3Q08 (Qtr End 10/31/07) Earnings Call Transcript

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