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Kevin Faulkner – Vice President Investor Relations

Alfred S. Chuang – Founder, Chairman, Chief Executive Officer, President

Mark P. Dentinger – Executive Vice President and Chief Financial Officer

William M. Klein - Vice President, Business Planning and Development


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


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

Kevin Faulkner

Thank you, Christian.  Good afternoon, ladies and gentlemen, and thank you for joining us as we discussed BEA Systems, Inc. results for the third quarter ended October 31, 2007, as well as results reflected in today's SEC filings.  Please note we've posted our earnings press release, the related financial tables, and the SEC filings themselves on our website at

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 the terminology such as may, will, expects, plans, estimates, 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 improved results due to sales profit changes, 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 Risk Factors in BEA's recent SEC filings 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.

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

With that, I'm pleased to introduce and turn the call over to 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, we have a lot of good news to report.  I'm proud of our team for delivering results at or above the high end of our guidance range for the third quarter and for completing our review and restatement, bringing us current again on our SEC filings.

Congratulations to the team for accomplishing all this despite 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 total license revenue.

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

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

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

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

These results demonstrate not only significant progress in our operating profitability they also represent a significant out performance relative to public market expectations.  We believe these results reflect the success of our multiyear companywide commitment to invest responsibly for growth while maintaining discipline in our cost structure.

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

Mark Dentinger

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

If you have questions about the filings, please contact our investor relations group or access the filings directly through BEA's website at or the SEC's website at

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

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

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

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

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

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

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

Licenses revenue decreased by 1% from last year's Q3 and services revenue increased 18%.  The largest component of services revenue, customer support, was $194.8 million dollars, a 17% increase compared to last year's Q3.

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

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

By product, the AquaLogic family contributed 27% of our Q3 license revenue versus 20% in Q3 of last year.  WebLogic and Tuxedo families contributed 73% of our license revenue in Q3 versus 80% in Q3 of last year.  Q3 total license transaction count of 2,506 increased approximately 2% from last year.  Our average transaction size decreased 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 were 14%.  Other verticals were individually less than 10% of license revenues for the quarter.

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

Total operating expenses for Q3 were $207.6 million dollars or 54% of total revenue compared with $204.5 dollars million in Q3 of last year or 59% of total revenue.  Sales and marketing 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% of revenue in Q3 of last year.  G&A expenses, 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-GAAP operating 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 last year.  The OIE improvement was largely the 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 in Q3 compared to 27.6% in Q3 of last year.  We expect our intermediate-term non-GAAP tax rate to approximate 27% to 29% based on current earnings distribution, but the quarterly rate can fluctuate based upon specific items that arise each period.  After making the previously mentioned non-GAAP adjustments, third-quarter net income on a non-GAAP basis was $0.19 per share or $78.9 million dollars.

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

Our Q3 results would have been approximately 4% lower in total revenue, 3% lower in cost of revenue and 3% lower in operating expenses if we had translated current quarter at currency exchange rates in effect last year.

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

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

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

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

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

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

The year-over-year 62% operating cash flow improvement was the result of our improved operating performance, combined with better balance sheet leverage.

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

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

I will now discuss our guidance for Q4.  The following comments and guidance are forward-looking statements, as are any other comments about our future financial and product performance.  You should review our Form 10-K for the year ended January 31, 2007 and our Form 10-Q for the quarter ended July 31, 2007, both of which contain 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.

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

Our comments on guidance are based on 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 or comments on future performance.  If we do update our comments and guidance, it is BEA's policy to do so through appropriate public disclosure.

In determining guidance, we are not assuming any significant change 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 from the recent volatility in the U.S. mortgage-backed securities markets.

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

Additionally, we expect our non-GAAP operating margins to be within 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-average shares 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 expenses in Q4 for final charges for third-party fees associated with completing our restatement; non-cash charges resulting from the final modifications of expiring stock option awards, which could not be sold until the restatement was completed.

Approximately $12.8 million dollars in cash expenses associated with final remedy of our current and former employees' exposure to 409A taxes; and approximately $6 million to $7 million in expenses for advisory fees associated with the unsolicited offer from Oracle and related activities.  These advisory fees will likely continue into next year.

Finally, I would direct your attention to a one-time reclassification in our cash flow statement for Q4 of ’07.  We previously disclosed $95 million dollars in cash flow from operations for that quarter.  As a result of adopting FAS 123(R) in fiscal 2007 and the fact that we drew down valuation reserves against deferred tax assets for the first time in ’07 during Q4 ’07.

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

We caution investors against using this number for trending or comparative purposes, because this cumulative catch-up concept will not be present in other quarters.  For modeling purposes, the $95 million dollars in positive cash flow we originally reported is probably a more accurate observation.

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

Notwithstanding the one-time catch-up in Q4 of ’07, the average quarterly benefit of this reclassification is about $3 million dollars.  With our restatement now complete, we anticipate some pent-up demand for our employees to exercise and sell their options during Q4.  And accordingly, the tax benefit reclassification will likely be considerably larger than normal next quarter.

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

In those presentations, I indicated that BEA was currently managing in a financial framework designed to generate 200 to 400 basis points of non-GAAP operating margin improvement in periods where we grow total revenue by 10% to 15%.

What is now visible is that if we can deliver a Q4 performance at the midpoint of our guidance range, we will actually achieve a 200 basis point improvement in operating margins in fiscal ’08 on a total top line growth of about 8.5%.  With our FY ’08 margin improvement trend now visible, investors and analysts have a better understanding of our margin expansion potential as we look forward to fiscal 2009.

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

Alfred Chuang

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

Japan continued its momentum for its third consecutive quarter.  Performance in Asia-Pacific was balanced, with noteworthy performance in Japan, China, and ASEAN.  The team is doing a great job driving AquaLogic adoption in the region, both with the end-user customer and also partners 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 we believe we are on track for continued improvement in the quarters to come.  In addition to the U.K., EMEA results are driven 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, VMware in the virtualization marketplace, which began in the U.S. several months ago and is now expanding to EMEA.  The EMEA pipeline looks very strong.

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

We do, however, have a strong American pipeline and anticipate a solid Q4 performance.  In Q3, our total revenue growth returned to the double-digit range that is tied to our margin improvement growth.  We achieved that by focusing on our customers' success and increasing penetration of our products in our customers' product environment.

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

To that end, we regularly structure customer contracts to increase the net present value of the order, in terms of total revenue, cash flow, and profitability.  That kind of structuring over the last few years has caused license revenue to become a less meaningful predictor of total revenue growth.

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

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

Our investments are focused on three main drivers of profitable growth.  First, it is our growing and emerging product areas such as SOA, virtualization and the triple-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 business applications as well as WebLogic Virtualization and the Communication Platform are on the verge of demonstrating huge success.

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

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

Third is our sales force and channel program, to improve our product distribution.  Our sales force execution programs have improved our productivity and visibility and contributed to our overall ability to leverage the cost base and drive profitable growth.

With additional improvement targeted in the Americas, we can make further progress.  We will continue to invest in these programs next year and also expand our channel program.  We believe our focus in these all three areas has contributed to meaningful and long-term growth prospects for BEA.

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

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

As we mentioned last quarter, the next SOA category to gain momentum was our governance products, which have grown about 130% compared to the first three quarters of last year.  In Q3, AquaLogic User Interaction had its best quarter ever, and is poised for growth with the introduction of our Pages, Ensembles, and Pathways products.

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

On the WebLogic front, WebLogic Communication Platform had its best quarter ever.  WebLogic Communication Platform continues to create opportunities to sell AquaLogic and WebLogic into the network side of our Telco customers and has a strong pipeline for Q4.

WebLogic Real Time and Advanced Server also had its best quarter ever.  Our new virtualization products have begun to gain reference customers.  The opportunity to sell virtualization upgrades to our WebLogic installed base represents a huge opportunity for us.  We have a strong go-to-market partnership with VMware to address this opportunity.

Now, let's talk about what all this means to our shareholders.  Our board has concluded that the recent unsolicited to offer to purchase BEA significantly undervalued the company.  This conclusion was based in 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 five quarters and which significantly exceeded the financial performance estimated by research analysts over the same period.

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

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

Our EPS growth, the disconnect between our actual growth and Street estimates and the growth opportunity for our new products are major considerations 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 the quarter and our financial results.

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

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

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

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

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

Kevin Faulkner

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

Question-and-Answer Session


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

Katherine Egbert - Jefferies

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

Mark Dentinger

Yes.  With respect to the 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 in the 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 the Americas, which are a tougher environment, but we were very pleased with the outcome.

Katherine Egbert - Jefferies

Did Virtualization Edition add any licenses this quarter?

Alfred Chuang

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

Katherine Egbert - Jefferies

Okay.  And then, last one.  Can you tell us specifically how you 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 our filings, I think all of our investors, also our financial analysts now, can come up and be able to see the significant improvement in profitability and see how all this will be able to translate into valuation.  We did all the valuation very carefully alongside 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 classical kinds of valuation techniques, trailing forward P/E multiples, comparable deals, DCF, synergy analysis.  So, it's pretty typical, standard stuff and the numbers kind of triangulated all in a pretty common point.

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

Katherine Egbert - Jefferies

Okay.  Is the synergy analysis specific to Oracle?

Bill Klein

The one I'm referring to is.

Katherine Egbert - Jefferies

Okay.  Thanks Bill.

Bill Klein

Thanks Katherine.


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

Derek Bingham - Goldman Sachs

Hi everyone.  It's Derek 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, and have put up some significantly bigger margins.

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

Mark Dentinger

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

But as you saw this year, we can do better in lower revenue growth scenarios and again, we will tend to our mindset going into next year will be to make sure that we're investing in the higher growth areas of the business, but being mindful of the proper trade-off between cost control and investing 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 pretty consistent rate, kind of closer to 20% for a long time.  Just some more specifics on where the tightening came from?

Mark Dentinger

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

But at this point, the biggest indicator is that the scale is working in our favor and we think we can continue to leverage the business at this point, and can continue to demonstrate the margin improvement we just showed you.

Derek Bingham - Goldman Sachs

Okay.  Perfect.  And just one more if I can, could you just give a little bit more color specifically on what you're seeing from verticals in 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, I think, around the globe.  I think the Americas we saw, I think, the usual softness that our other relating companies are seeing 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 are not seeing.  I think our Telco sector has performed very well in the quarter, and some of the other areas of manufacturing in retail and in government.  So, we do expect, I think some of those are going to continue to do well going into Q4.

Derek Bingham - Goldman Sachs

Got it.  Thank you very much.  Congratulations.

Alfred Chuang

Thanks Derek, I appreciate.


Our next question comes from the line of Adam Holt with JPMorgan.  Please go ahead with your question.

Adam Holt - JPMorgan

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

Alfred Chuang

Yes.  Adam I can hear you well.  Thanks.

Adam Holt - JPMorgan

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

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

Alfred Chuang

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

So clearly, I think on similar indirect channel kick in for some 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 of our costs from the direct side and the indirect side.

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

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

Other countries in ASEAN, like Thailand, the Philippines and areas like that, we will continue to grow those in terms of indirectly supporting the channel, penetrating those marketplaces.

We will selectively and be aggressive in terms of our investment in the direct sales force in the Americas going into next year.  So, I wouldn't read too much into the different reload balancing acts, while we're going through the channel at this point in time.

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

Adam Holt - JPMorgan

And if I could just follow-up on your comment about the Americas 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 a year-on-year basis in the quarter.  It sounds like that's not an area where you're going to be investing aggressively on 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, we have a lot of work to do in terms of improving our sales execution.  We saw, I think, a notable sales execution improvement in the quarter and obviously, we will continue to invest in the Americas.

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

Adam Holt - JPMorgan

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

Alfred Chuang

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

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


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

John Walsh - Citigroup

Good afternoon.  Just on that last point, would it be likely to be then, after the shareholder meeting, buyback, and exploration activity?

Alfred Chuang

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

John Walsh - Citigroup

Okay.  And then, Mark, in the quarter, there's a number of adjustments made.  Maybe walk us through, specifically, deferred compensation 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 deferred compensation expense, why that adjustment and income adjustment?

Mark Dentinger

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

And that's the deferred compensation that gets recorded when you do an acquisition related to stock incentives to employees that you're bringing onto your books.  And we typically sweep those out, and it's analogous to the FAS 123(R) sweep that we also do.

I couldn't understand your second …

John Walsh - Citigroup

Yes, the restatement adjustment.

Mark Dentinger

Yes, the restatement adjustment, so there are two categories.  One are the costs associated with actually finishing the restatement, and there's also some continuing adjustments that will linger out and basically will probably wrap up by the end of Q4 associated with employment taxes and things like that, that are spilling over 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 of cash there, but they are fairly small.  In the case of the expenses associated with completing the restatement, they would be cash-related.

John Walsh - Citigroup

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

Alfred Chuang

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

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

And we will obviously as time continues and we pick up continue to see this momentum, we probably will be breaking out and show you what we're doing in the area.  So, more to come in the area, very positive.

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

John Walsh - Citigroup

Okay.  Thanks.

Alfred Chuang

Thank you.


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

John DiFucci - Bear Stearns

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

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

Mark Dentinger

Yes, John.  The starting point is that we believe we're approaching an inflection point in leverage and our ability to generate more revenue basically within the same cost envelope.  And although that doesn't preclude us from investing in the high growth areas of the business, I think we're just being smarter where we invest the dollars with respect to the return we'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 as aggressively as we are and we believe we grow that faster than our competitors in the industry.  As long as that grows as quickly as it does, operating leverage is always a possibility.

John DiFucci - Bear Stearns

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 GAAP expenses that are newly excluded from your non-GAAP results.  Even the advisory fees, I can sort of understand that, but you say it's going to be recurring going forward.

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

Mark Dentinger

Yes, the advisory fees are an interesting area, because we're in a particular, a unique situation of having both a hostile bid for the company and a shareholder activism, a highly profiled shareholder activism circumstances.

So, we are absorbing these, and we don't believe that both of these circumstances can continue for the long run.  So, as I indicated, I do believe that they will 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 special exempted items coming out of the non-GAAP to non-GAAP bridge are related essentially around all of the restatement efforts and cleaning up matters related to the restatement.

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

John DiFucci - Bear Stearns

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

So, we've actually had all that already.  So is that something that you believe, based on 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 forward and trailing P/E multiples, growth rates and …

John DiFucci - Bear Stearns

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

Bill Klein

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

John DiFucci - Bear Stearns

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

Bill Klein

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

John DiFucci - Bear Stearns

Okay.  Okay.  Thanks a lot.


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

Todd Raker - Deutsche Bank

Hey, guys few question.  First, I was hopeful you could give us some insight, when you talk about exploring shareholder value on that path, what exactly 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 going to go into the details or comment on what process we are looking at or who we might be talking to.  But I think it's safe to say that we're actively exploring ways to maximize shareholder value and we're using our time wisely.

Todd Raker - Deutsche Bank

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

Alfred Chuang

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

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

Todd Raker - Deutsche Bank

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

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

Alfred Chuang

Well, it's a great question because, I tell you, this shows how 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 our technology very strongly, which is why we're investing so heavily in R&D.

And that penetration goes two ways, one is more projects are being developed in these organizations.  Particularly they are going through this web modernization and a lot of these new activities that 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 those accounts.

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

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

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

Todd Raker - Deutsche Bank

Okay.  Thanks guys.

Alfred Chuang

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


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

Jason Maynard - Credit Suisse

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

Bill Klein

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

In this year, even in a flat license scenario, we can still achieve leverage.  So the purpose of putting 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 software companies have faced and this is more of a historical comment.  When they are around the $1 billion, $1.5 billion mark, it’s been difficult sometimes to really push those margins to 28%, 30% level without more sustained license revenue because, obviously, license revenue being the catalyst to add more subscribers and maintenance revenue.

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 the margins a couple of hundred basis points?

Bill Klein

The real difference in our model Jason is that the support structure is incredibly sticky.  As Alfred alluded to earlier, our renewal rates are phenomenal and our pricing discipline around support is phenomenal and those two phenomena are a testament to the technology.

Once our customers get on the technology, they are very loyal.  They very, very rarely go away.  Getting then on there, that makes our circumstances probably not comparable to all of the other comparables that you look at.  That phenomenon has been present for several years, and there's no reason to believe that's going to change.

Jason Maynard - Credit Suisse

Okay.  Thanks for the question.

Alfred Chuang

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

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

Deferred revenue was $388.6 million, up 15% year-to-year.  GAAP operating profit was $64.3 million, up 70% from a year ago.  GAAP operating margin 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 was up from $0.08 a share a year ago.  Cash flow 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 to year, 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 I apologize for the technical difficulties.  I look forward to speaking to you through the quarter and also in our next earnings call.  Thank you very much.


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

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