10-K 1 d10k.htm FORM 10-K Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 


FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934.

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended January 31, 2007

OR

 

¨ TRANSITION REPORT UNDER TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 0-22369

 


BEA SYSTEMS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware   77-0394711

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I. R. S. Employer

Identification No.)

2315 North First Street

San Jose, California 95131

(Address of Principal Executive Offices)

(408) 570-8000

(Registrant’s telephone number, including area code)

 


Securities registered under Section 12(b) of the Act:

 

Title of Each Class   Name of Each Exchange on Which Registered

Common Stock, $.001 Par Value

Preferred Share Purchase Rights

 

The NASDAQ Stock Market LLC

(The Nasdaq Global Select Market)

Securities registered under Section 12(g) of the Act: None

 


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ¨    No  x

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer  x            Accelerated Filer  ¨            Non-Accelerated Filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨    No  x

The aggregate market value of the voting common stock held by non-affiliates of the registrant, computed by reference to the closing price at which the common stock was sold on July 31, 2006, as reported on the Nasdaq National Market, was approximately $4.4 billion. Shares of common stock held by each officer and director have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status does not reflect a determination that such persons are affiliates for any other purposes.

As of October 31, 2007, there were approximately 398,272,000 shares of the registrant’s common stock outstanding.

 


DOCUMENTS INCORPORATED BY REFERENCE

None

 



Table of Contents

BEA SYSTEMS, INC.

FORM 10-K

FOR THE FISCAL YEAR ENDED JANUARY 31, 2007

INDEX

 

          Page
   Explanatory note    2
PART I

Item 1.

   Business    7

Item 1A.

   Risk Factors    20

Item 1B.

   Unresolved Staff Comments    36

Item 2.

   Properties    36

Item 3.

   Legal Proceedings    37

Item 4.

   Submission of Matters to a Vote of Security Holders    39
PART II

Item 5.

  

Market for Registrant’s Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   40

Item 6.

   Selected Financial Data    42

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    45

Item 7A.

   Quantitative and Qualitative Disclosure about Market Risk    88

Item 8.

   Financial Statements and Supplementary Data    91

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    166

Item 9A.

   Controls and Procedures    166

Item 9B.

   Other Information    169
PART III

Item 10.

   Directors, Executive Officers and Corporate Governance    169

Item 11.

   Executive Compensation    174

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   194

Item 13.

   Certain Relationships and Related Transactions, and Director Independence    197

Item 14.

   Principal Accounting Fees and Services    197
PART IV

Item 15.

   Exhibits and Financial Statement Schedules    199

Signatures

   203


Table of Contents

Explanatory Note

Restatement of Financial Information. In this Annual Report on Form 10-K as of and for the year ended January 31, 2007 (the “2007 Form 10-K”), BEA Systems, Inc. (the “Company” or “we”) restated its Consolidated Balance Sheet as of January 31, 2006 and its Consolidated Statements of Income and Comprehensive Income, Shareholders’ Equity and Cash Flows for each of the fiscal years ended January 31, 2006 and 2005 as a result of an independent stock option review initiated by the Company’s Board of Directors and conducted by its Audit Committee. This restatement is more fully described in Note 2, “Restatement of Consolidated Financial Statements,” to Consolidated Financial Statements and in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” This 2007 Form 10-K also reflects the restatement in Item 6, “Selected Consolidated Financial Data”, for the fiscal years ended January 31, 2006, 2005, 2004 and 2003. In addition, the Company is restating its unaudited quarterly financial information and financial statements for interim periods of fiscal 2006 and for the three months ended April 30, 2006.

Financial information included in the reports on Form 10-K, Form 10-Q and Form 8-K filed by the Company prior to December 4, 2006, and the related opinions of its independent registered public accounting firm, and all earnings press releases and similar communications issued by the Company prior to December 4, 2006 should not be relied upon and are superseded in their entirety by this 2007 Form 10-K and other reports on Form 10-Q and Form 8-K filed by the Company with the Securities and Exchange Commission on or after December 4, 2006.

Independent Review Overview. On August 14, 2006, the Audit Committee recommended to the Board, and the Board agreed, that the Audit Committee retain independent counsel to assist with a thorough review of the Company’s historical stock option grant practices (“Independent Review”). The Audit Committee conducted the Independent Review with the assistance of independent legal counsel Simpson Thacher & Bartlett LLP (“Simpson Thacher”) and forensic accountants Navigant Consulting, Inc. (“Navigant”), collectively the (“Review Firms”). The Independent Review, which commenced in August 2006 and encompassed all of the Company’s stock option grants from January 1996 through June 2006 (“Review Period”), excluding stock options acquired as part of business combinations, consisted of a review of the Company’s historic stock option granting practices, including a review of whether we used appropriate measurement dates, and, therefore, correctly accounted for stock option grants made under equity award programs.

The summary of the impact of the stock-based compensation and related issues, based on the findings of the Independent Review, for the fiscal years ended January 31, 1998 through 2006 is as follows:

 

Fiscal Year

   Pre-Tax Expense
(Income)
    After Tax Expense
(Income)
 

1998

   $ 827     $ 827  

1999

     2,983       2,983  

2000

     29,754       29,754  

2001

     185,125       159,272  

2002

     109,399       100,347  

2003

     66,623       42,961  

2004

     42,701       10,638  
                

Subtotal

     437,412       346,782  
                

2005

     (10,662 )     (14,641 )

2006

     (2,762 )     (427 )
                

Total

   $ 423,988     $ 331,714  
                

 

2


Table of Contents

PART I

FORWARD-LOOKING INFORMATION

This Annual Report on Form 10-K (this “Annual Report” or “2007 Form 10-K”) includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). All statements in this Annual Report other than statements of historical fact are “forward-looking statements” for purposes of these provisions, including any statements of the plans and objectives for future operations and any statement of assumptions underlying any of the foregoing. Statements that include the use of terminology such as “may,” “will,” “expects,” “plans,” “anticipates,” “estimates,” “potential,” or “continue,” or the negative thereof or other comparable terminology are forward-looking statements. Forward-looking statements include, without limitation, statements related to:

 

   

fluctuation of revenues and operating results, including as a result of seasonality;

 

   

the effect of volatility of licensing revenues on our ability to accurately forecast revenues, expenses and operating results;

 

   

the effect of the length of our sales cycle on our revenues;

 

   

the restructuring of our sales force, our sales through distribution channels and the resulting effect on our margins and revenues;

 

   

our competition and technology, market and industry conditions and our need to adapt to such conditions;

 

   

the dependence of our growth on the implementation and introduction of our new product initiatives;

 

   

protection of our intellectual property rights;

 

   

defense against potential intellectual property claims against us and our exposure to litigation if our products contain software defects;

 

   

the effect of our relationships with third-party vendors on the supply of our products;

 

   

risks attendant to conducting international operations;

 

   

the effect of changes in accounting regulations on our revenue and profits;

 

   

the effect of changes in taxes we owe on our profitability;

 

   

our inability to manage growth;

 

   

the importance of hiring and retaining key personnel;

 

   

the integration of our past and future acquisitions;

 

   

risks in connection with Plumtree’s government contracts and their effect on our results of operations;

 

   

the effect of U.S. military activity and terrorism on our revenues and operations;

 

   

the effect of government review of our income and payroll tax returns or changes in our effective tax rates on our operating results;

 

   

the effect of the incorrect accounting for our stock options on our financial results;

 

   

the time and expense incurred by our review of and financial restatement in connection with our historical stock option practices;

 

   

non-compliance with SEC reporting and Nasdaq listing requirements;

 

   

litigation relating to our historical stock option grant practices;

 

   

effective internal controls over financial reporting;

 

3


Table of Contents
   

compliance with corporate governance requirements;

 

   

the difficulty of obtaining director and officer insurance coverage due to the results of our stock option review;

 

   

the impact on our business and stock price of any potential acquisition or other transaction involving us;

 

   

any potential acquisition or other transaction involving us and actions by activist investors related thereto;

 

   

the impact of the uncertainty of our future in light of potential acquisitions, especially with respect to our customer and our employees;

 

   

litigation relating to any potential acquisition or other transactions involving us;

 

   

future amortization of acquired intangible assets;

 

   

facilities consolidation charges, for estimated future lease commitments on excess facilities;

 

   

future stock repurchases under our stock repurchase program;

 

   

the development of an expanded product set for SOA service infrastructure through expansion in our messaging, portal infrastructure, data integration, security, Web services management and other technologies;

 

   

our ability to attract Chief Information Officers to choose our products as the architectural foundation of SOA projects to be implemented over a sustained period of time;

 

   

the trend toward increased high dollar transactions;

 

   

the expectation that future payments of facilities consolidation charges will not significantly impact our liquidity due to our strong cash position;

 

   

the realizability of deferred tax assets;

 

   

our belief that our tax positions are consistent with the tax laws in the jurisdictions in which we conduct business;

 

   

that we do not anticipate paying any cash dividends in the foreseeable future;

 

   

unrecognized compensation costs related to stock options, restricted stock and the ESPP;

 

   

our belief that the amount of liability associated with our current legal proceedings will not materially affect the Company’s financial position;

 

   

our acquisition strategy to use cash or stock or purchase development teams or technologies to add features or products that complement or expand our products;

 

   

our belief that the cost of license fees may increase in absolute dollars in fiscal 2007;

 

   

the requirement that we must maintain certain covenants, including liquidity, leverage and profitability ratios associated with our long term debt facility;

 

   

significant cash and/or financing resources needed for the construction of office facilities and the adequacy of our facilities;

 

   

the estimate and fluctuation of interest payments;

 

   

sufficiency of existing cash;

 

   

the dependence on continued expansion of international operations;

 

   

our initiative to recruit and train a large number of consultants employed by SIs and to embed our technology in products that our ISV customers offer;

 

4


Table of Contents
   

the need to expand our relationships with third parties in order to support license revenue growth;

 

   

the dependence on our ability to attract and retain qualified sales, technical and support personnel;

 

   

the intention to expand our global organization;

 

   

continued adoption of Java technologies;

 

   

the dependence on continued growth in the use of the Web to run software applications;

 

   

the intention to make additional acquisitions in the future;

 

   

significant accounting charges as a result of expensing stock option grants and awards under FAS 123(R);

 

   

the dependence on our proprietary technology;

 

   

the need to continue to improve our operational, financial, disclosure and management controls, reporting systems and procedures and information technology infrastructure;

 

   

the update of our management information systems to integrate financial and other reporting;

 

   

the development and roll out of information technology initiatives;

 

   

the dependence on future performance to meet our debt service obligations;

 

   

the requirement of substantial amounts of cash to fund scheduled payments of principal and interest on our indebtedness, future capital expenditures, payments on our operating leases and any increased working capital requirements;

 

   

our recognition of Fuego and Plumtree support contracts over their respective renewal periods;

 

   

our focus to expand our product set by expanding our existing application infrastructure products and service infrastructure products and broadening our application infrastructure products into targeted emerging use cases;

 

   

the inherent volatility of transactions greater than $1 million; and

 

   

our initiative to further establish and expand relationships with our distributors.

These forward-looking statements involve risks and uncertainties, and it is important to note that our actual results could differ materially from those projected or assumed in such forward-looking statements. Our actual results could differ materially from those discussed in this Annual Report. Important factors that could cause or contribute to such differences include difficulties in developing new technologies; unanticipated delays in bringing our products to the market; product defects in the development phase that could cause delays; unanticipated shortages of cash available to invest in building relationships and expanding distribution channels; an unanticipated lack of resources to invest in increasing direct sales and support organizations; political instability; the inability to establish customer and product development relationships; difficulties of our services organization in providing a consistent level of support; unanticipated changes in key personnel; the possibility that customers will switch to competitors products; unanticipated shortages of cash to invest in product development; unanticipated delays in the completion of construction of the San Jose facility; unanticipated growth resulting in a shortage of space in existing facilities; uncertainty of the ultimate outcome of litigation; inherent uncertainty surrounding the litigation process and our inability to accurately predict the determination of complex issues of fact and law; the inability to generate cash for operations to support our business; the risk that we may be required to expend more cash in the future than anticipated and may be unable to support our operations; difficulty in predicting size and timing of customer orders; unanticipated changes in our incentive structure; economic downturns; the risk that we may not be successful in obtaining orders from our customers; inability to predict the level of future sales of our products; unanticipated fluctuations in interest and foreign currency exchange rates; a downturn in our sales or defaults on payments by customers; uncertainties as to the assumptions underlying our calculations regarding estimated annual amortization expenses for purchased

 

5


Table of Contents

intangible assets; unanticipated difficulties in development of products with third parties; unanticipated costs and expenses arising from the leased facilities; unanticipated changes in tax regulations; unanticipated shortages of cash; uncertainties as to the effects of certain accounting policies; a lack of the required resources to invest in the development of existing and new products; substantial technological changes in the software industry; significant changes in customer preferences; risks and uncertainties associated with international operations, including economic downturns, trade balance issues, fluctuations in interest and foreign currency exchange rates; better than expected cash generated from operations; unanticipated difficulties in integration of our products with other ISV’s products; our inability to successfully retain or recruit executive officers and key personnel; a change in the level of importance of stock options to employee recruitment; delays in bringing new products or enhancements to market due to development problems; the risk that we may not be successful in obtaining new orders from major customers; uncertainty of suitable companies, divisions or products available for acquisition; unanticipated difficulties affecting management of growth; uncertainties as to the prospect of future orders and sales levels; uncertainties as to the future level of sales and revenues; unanticipated operating and business expenses preventing us from meeting debt obligations; unanticipated interest changes and defaults on payments owed to us; miscalculations with respect to stock compensation expenses; and other factors that could cause actual results to differ materially such as those detailed under the headings “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors.” All forward-looking statements and risk factors included in this document are made as of the filing date hereof, based on information available to us as of the filing date hereof, and we assume no obligation to update any forward-looking statement or risk factor. You should also consult the risk factors listed from time to time in our Reports on Form 10-Q and our other SEC filings.

 

6


Table of Contents
ITEM 1. BUSINESS.

Overview

The information below has been adjusted to reflect the restatement of our financial results which is more fully described in the “Explanatory Note” immediately preceding Part 1, Item 1 and in Note 2, “Restatement of Consolidated Financial Statements,” in Notes to Consolidated Financial Statements of this Form 10-K.

BEA® Systems, Inc. (referred to as “we”, “us”, “BEA” or the “Company”) is a world leader in enterprise application and service infrastructure software. Application infrastructure provides an important part of the foundational software necessary for enterprise applications to run reliably and securely, to serve large numbers of users and to process large numbers of transactions. Application infrastructure is deployed on top of the operating system and database in an enterprise server and serves as a platform technology for either custom or packaged enterprise applications. Two of our three primary product families address this market. Specifically, our BEA Tuxedo® product family, which is an application infrastructure platform for large transactional processing systems for C, C++ and COBOL systems, and BEA WebLogic® product family, which consists of application infrastructure software for Java applications, perform functions such as transaction processing, clustering, caching, load balancing, failover, security, integration and management features, all of which provide high levels of reliability, availability, scalability and performance for enterprise applications. To meet a broader set of customers’ application infrastructure needs, BEA has leveraged its success in the application server market by expanding into adjacent product categories that take advantage of the performance and features provided by the underlying application server. The application infrastructure market consist of the application server market and products, as well as related integration, portal, security, development, operations, administration and management markets and product categories. New use cases for application infrastructure are beginning to emerge, such as applications with near real time performance requirements; virtualized applications; edge devices such as embedded sensors, control devices, and radio frequency identification (“RFID”) devices; and next generation telephony applications such as voice, video and data services over internet protocol. BEA is introducing application infrastructure products specialized for these customer uses.

More and more customers are migrating away from systems where users directly interface with a specific application and towards systems where users interface with Web-based portals and composite applications, which in turn interface with several enterprise applications. This information technology (“IT”) strategy is often referred to as Service-Oriented Architecture (“SOA”). This migration has created the need for a new category of software, called “service infrastructure,” residing on top of enterprise applications and serving as the platform for portals, automated business processes and composite applications. Service infrastructure provides a flexible SOA platform for deploying, integrating, securing, governing and managing services, regardless of the platform on which they were created. Service infrastructure also provides a platform for leveraging these services in the creation and management of automated business processes, portals, collaborative communities, and composite applications. In June 2005, BEA launched BEA AquaLogic®, a new family of products designed to address a variety of needs in the service infrastructure category. This product family includes products and capabilities in the areas of user interaction, business process management, enterprise service bus, Web services management, data integration services, service registry, enterprise repository, and security policy management. In September 2007, BEA announced a new development initiative, Project Genesis, to provide infrastructure for the next generation of SOA applications. Genesis converges SOA, business process management, enterprise social computing and other technologies to provide customers with a fast, simplified way to assemble and modify business applications. BEA has developed and acquired significant features or product lines to address these markets and is in the process of developing and adding additional features and products.

BEA’s product focus today has three main elements: (1) selling a broad application infrastructure platform, with the individual elements tightly integrated into a single product, but also available for purchase as individual units; (2) extending application infrastructure into emerging use cases; and (3) selling a broad service infrastructure platform, with the individual elements tightly integrated into a single platform, but available for purchase as individual units. Our modular but tightly integrated approach allows us to service the application and

 

7


Table of Contents

service infrastructure markets by enabling customers to buy just the modules needed for a specific project then to easily unify and extend those modules into a platform as they deploy subsequent projects, or to buy the entire platform at once.

Our products have been adopted in a wide variety of industries, including telecommunications, commercial and investment banking, securities trading, government, manufacturing, retail, airlines, pharmaceuticals, package delivery and insurance. Our products serve as a platform for systems such as billing, provisioning, customer service, electronic funds transfer, ATM networks, securities trading and settlement, online banking, Internet sales, inventory management, supply chain management, enterprise resource planning, scheduling, logistics and hotel, airline and car rental reservations. In addition, we offer associated customer support, training and consulting services. Our products have garnered several awards and distinctions. In 2006, BEA AquaLogic® Service Bus won Network Computing’s Editor’s Choice Award for Best Enterprise Service Bus, and the 6th Annual eWeek Excellence Award. Also in 2006, BEA Workshop, our Java developer tool set, won Best Commerical Eclipse based developer tool.

Licenses for our products are typically priced on a per-central processing unit (“CPU”) basis, but we also offer licenses priced on other bases. Our products are marketed and sold worldwide directly through a network of sales offices and the Company’s Web site, as well as indirectly through distributors, value added resellers (“VARs”) and partnerships with independent software vendors (“ISVs”), application service providers (“ASPs”), hardware original equipment manufacturers (“OEMs”) and systems integrators (“SIs”).

Products

BEA Tuxedo® Family of Products

BEA Tuxedo® is an application infrastructure platform for applications written in the C, C++, and COBOL programming languages. BEA Tuxedo serves as the platform for large, mission-critical transaction processing systems such as interbank transfers, ATMs, credit card transactions, telecommunication billing applications and enterprise financial systems. BEA Tuxedo® provides the rugged platform required to run these high-volume applications across distributed, heterogeneous computing environments. In this way, Tuxedo® enables transactions that stretch from customer-facing, business-critical applications to back-office processes, across disparate systems and across the world. Applications written on BEA Tuxedo can be made available as Web services, enabling those applications to be accessed in a service-oriented architecture.

The WebLogic® Family of Products

BEA WebLogic® Platform

The BEA WebLogic® Platform—which includes BEA WebLogic® Server, BEA WebLogic® Portal, BEA WebLogic® Integration and BEA Workshop—is a leading application platform suite for Java developers building enterprise applications, SOA services and portals, as well as enterprise application integration.

BEA WebLogic® Server

BEA WebLogic® Server is an enterprise-grade application server, based on Java standards and supporting applications written in the Java programming language. It provides the core functions necessary for Java applications and also provides clustering of multiple servers, load balancing, caching, server migration and failover capabilities. These capabilities help meet enterprise applications’ availability, scalability and performance needs. BEA WebLogic® Server also provides features such as advanced administration tools, reliable messaging and support for popular development frameworks derived from open source communities, such as Spring and Apache Struts. In standard industry benchmarks, results submitted on BEA WebLogic® Server demonstrate that applications built on BEA WebLogic® Server need significantly less hardware to process a given number of transactions when compared to competitive

 

8


Table of Contents

products. This performance advantage, along with ease of use features aimed at developers and system administrators, collectively reduce the cost of building, operating and maintaining enterprise applications running on WebLogic® Server and allow us to maintain premium price points.

BEA WebLogic® Portal

BEA WebLogic® Portal provides a flexible and robust foundation for customized enterprise portals. Based on BEA WebLogic® Server, BEA WebLogic® Portal provides core functions necessary for scalable, reliable portals supporting large numbers of transactions. In addition, BEA WebLogic® Portal supports standards-based integration of content and application functionality into portals, and provides tools to facilitate the creation and management of portals. BEA WebLogic® Portal includes pre-integrated business services, such as content management, search, collaboration and commerce.

BEA WebLogic® Integration

BEA WebLogic® Integration delivers a standards-based ability to connect existing, disparate enterprise applications to produce a set of shared business services. Based on BEA WebLogic® Server, BEA WebLogic® Integration provides the core functions necessary for scalable, reliable connections between enterprise applications, supporting large numbers of transactions. By delivering shared business services independently from the underlying applications, enterprises can facilitate information access to multiple constituencies, such as employees, customers and partners. BEA WebLogic® Integration also provides functionality such as modeling, automation and analysis of business processes, integration of internal applications, integration with trading partners, event-driven data flow inside the enterprise and with trading partners, data transformation between different formats, the ability to publish business processes as Web services for service-oriented architecture, and administration tools to monitor and manage system performance.

BEA Workshop

BEA Workshop provides professional tools for the development of service-oriented enterprise applications. BEA Workshop also enables development of portals, application integration and business process flows. BEA Workshop supports popular development environments and frameworks, such as Eclipse, Spring, Hibernate, Struts, Tiles and Java Server Frameworks.

BEA WebLogic Server, Virtual Edition

BEA WebLogic Server Virtual Edition is a Java environment optimized for virtualized hardware environments. Through a highly tuned Java virtual machine and operating system compression, it streamlines the software supporting enterprise applications. This allows more applications per server, significantly reducing hardware and operations cost, and greatly simplifying deployment. BEA WebLogic Server Virtual Edition also improves system agility, by making it easier to provision new applications or SOA services. BEA WebLogic Server Virtual Edition enables rapid development of services, while providing a runtime platform for reliability, availability, scalability, high performance and management of those services.

BEA WebLogic® Communications Platform

Historically, BEA’s primary role in the telecommunications industry has been to provide the platform for back-office and operational systems, such as billing and provisioning applications, call centers and online customer self-service. Next-generation telecommunications services based on internet protocol are beginning to emerge, such as voice and video over internet protocol and data services. These services are specialized applications running on the internet. BEA believes the emergence of these next-generation services will create an opportunity to provide infrastructure to enable these services to run reliably, support large numbers of users and support large volumes of data flow.

 

9


Table of Contents

To service this emerging opportunity, BEA introduced the BEA WebLogic® Communications Platform, which includes the BEA WebLogic SIP Server® and the BEA WebLogic Network Gatekeeper®. BEA WebLogic Communications Platform is the first converged information technology and telecommunications platform, and provides core infrastructure capabilities in a carrier-grade environment. The platform enables telecommunications carriers to deploy a wide variety of digital content and video services over wireless and wireline networks, including multimedia, real-time conferencing, multi-player gaming (with voice), real-time/interactive voting, click-to-call and unified messaging.

BEA WebLogic® SIP Server

BEA WebLogic® SIP Server is a high-performance application server, which provides an integrated environment to support Java standards, internet standards such as HTTP, and emerging standards such as session initiation protocol (“SIP”) and internet protocol multimedia subsystems (“IMS”). BEA WebLogic® SIP Server enables rapid development and delivery of next-generation, multimedia communication services. Through very strong technical integration with BEA WebLogic Server, the BEA WebLogic® SIP Server offers the following key features:

 

   

Integrated Java EE and SIP application container

 

   

IMS support

 

   

Industry standards support

 

   

Carrier-grade performance

 

   

High availability, reliability and scalability

 

   

Multi-network interoperability

 

   

Rapid creation of innovative services

 

   

Mission critical manageability

BEA WebLogic® Network Gatekeeper

Next-generation systems enable telecommunications carriers to open their networks to third-party providers, for content and services such as news, sports scores, online banking, video streaming and interactive gaming. While opening their networks to third party providers, the telecommunications carriers remain responsible for managing network performance to ensure network availability, network reliability and prioritization of network traffic (such as 911 calls). BEA WebLogic® Network Gatekeeper provides a carrier-grade, industry standards-based platform for policy-based network protection and application access control, to manage network performance. BEA WebLogic® Network Gatekeeper also enables automated partner management and flexible billing management, to ease the process of deploying third party services into the network and billing for those services. Operators can utilize its dynamic traffic throttling, policy-based application access control, and network protection features to enhance performance of application and partner platforms, improve network stability and capacity, and increase revenues through prioritizing premium traffic.

BEA WebLogic Event Server

An emerging market opportunity is infrastructure to support event-driven applications. Enterprises are creating more, larger and more complex streams of data as their IT systems broaden. Enterprises now have available to them streams of complex data, such as stock quotes, and real-time personnel, vehicle and inventory location. Enterprises are beginning to build new IT systems that take advantage of this data, act on it, and use it to predict future events. Event-driven applications use these data streams as inputs, rather then relying solely on human input data. Event-driven applications then use these data streams to discern complex event patterns,

 

10


Table of Contents

correlations across different event sources, and potentially to trigger other activities. Use cases include arbitrage systems in financial services, and tracking and routing in transportation, supply chain and logistics. BEA WebLogic Event Server is a Java server to provide infrastructure for high-performance event-driven applications. BEA WebLogic Event Server provides customers with the capability of handling thousands of events and rules per second at extremely low latency. It includes a complex event processing engine that aggregates information from distributed systems, applies rules to that information to discern patterns, and provides the ability to correlate events or trigger actions based on those inputs and rules.

BEA WebLogic® RFID Product Family

Customer usage of application infrastructure is also beginning to broaden into the usage of radio frequency identification (“RFID”) for tracking of inventory, reusable assets, baggage and packages. RFID involves tagging items to be tracked with a small radio device, installation of readers in various locations to track the items, and creation of applications and computer systems to capture, analyze and use data provided by the tracking system. BEA’s WebLogic® RFID edge and enterprise products deliver a standards-based RFID infrastructure platform designed to automate new RFID-enabled business processes. The combination of BEA’s RFID infrastructure technology and BEA’s application and service infrastructure products allow customers to capture RFID data and use that information in core applications.

BEA WebLogic® RFID Edge Server

BEA WebLogic® RFID Edge Server delivers a software infrastructure for developing, deploying, and managing robust RFID solutions. It allows customers to make RFID technology an integral part of their enterprise and realize the benefits that RFID offers, including improving supply chain visibility, automating business transactions and protecting inventory and assets.

BEA WebLogic® RFID Enterprise Server

BEA WebLogic® RFID Enterprise Server provides the standards-based infrastructure for centrally managing RFID data collected at the edge of an enterprise. It allows users to get a view of product movement data as well as enabling the central provisioning of RFID data in distributed tagging operations.

BEA WebLogic® Real Time, Core Edition

BEA WebLogic® Real Time is a new lightweight, low-latency Java-based server that provides response times in the milliseconds for performance-critical real-time applications.

BEA JRockit®

The Java Virtual Machine (“JVM”) is a key foundation technology of the Java platform—the technology responsible for Java’s hardware and operating-system independence. BEA JRockit® JVM delivers a number of unique, industry-leading technological advances that improve system performance, application debugging and memory leak control.

BEA JRockit® includes an automatic memory-management technique, the Deterministic Garbage Collector, designed to enable predictable, minimal transaction latency. This new capability helps enable the use of Java technology in highly time-sensitive applications such as financial trading, where Java was previously impractical due to unacceptable transaction latency.

BEA JRockit®’s Mission Control suite of non-intrusive monitoring and debugging tools is designed to deliver a rich set of operational information with minimal overhead, helping enable application profiling, debugging and tuning in production environments.

 

11


Table of Contents

In addition, BEA JRockit® delivers high performance with record-setting published benchmarks, a small memory footprint, quick start-up times, adaptive self-healing memory management, solid core processing and other features that help bring systems closer to zero downtime.

BEA AquaLogic® Family of Products

Rather than requiring users to log on serially to one application after another in order to accomplish various tasks, businesses are more and more offering users robust portals that draw data and application functionality from many sources. However, the flow of information across these different sources is hindered by the heterogeneous nature of the typical large enterprise. An enterprise might want to connect systems based on multiple platforms and technologies (mainframe, client/server, packaged applications, Web-based systems, J2EE, .NET, etc.). Connecting these disparate systems required building and maintaining multiple point-to-point connections. This process is difficult and expensive to build and maintain. As a result, enterprises are seeking more efficient ways to deliver new business services that implement new ideas and business models.

Service-Oriented Architecture (“SOA”) has emerged as the leading information technology (“IT”) strategy for streamlining delivery of new business services. SOA is an approach to building enterprise systems that enables the discrete business functions contained in enterprise applications to be organized into interoperable, standards-based services that can quickly be combined and reused in composite applications and processes. Service infrastructure is a new class of software products designed for managing SOAs in environments using disparate technologies.

The BEA AquaLogic® family delivers a broad line of service infrastructure products to help enable and manage successful SOA deployment. The BEA AquaLogic® family delivers a unified set of products that handles user interaction, business process management, service integration, service management, data unification, and security needs. BEA AquaLogic® consists of the following products:

BEA AquaLogic® User Interaction

BEA AquaLogic® User Interaction is an integrated family of products used to create enterprise portals, collaborative communities and composite applications, all built on a service infrastructure.

BEA AquaLogic® BPM Suite

BEA AquaLogic® BPM Suite bridges human workflow technology and enterprise application integration in a single suite to support today’s complex, collaborative business processes.

BEA AquaLogic® Service Bus

BEA AquaLogic® Service Bus provides a market-leading enterprise service bus combining intelligent, high-performance service integration and mediation with operational service management and support for service life-cycle governance.

BEA AquaLogic® Data Services Platform

BEA AquaLogic® Data Services Platform is the industry-leading data services platform that delivers live, integrated and reusable information as a service.

BEA AquaLogic® Enterprise Security

BEA AquaLogic® Enterprise Security combines centralized security policy management with distributed policy decision-making and enforcement to simplify adaptation to changing business requirements.

 

12


Table of Contents

BEA AquaLogic® Enterprise Repository

BEA AquaLogic® Enterprise Repository provides visibility, traceability and governance of the enterprise software asset portfolio to ensure architectural alignment.

BEA AquaLogic® Service Registry

BEA AquaLogic® Service Registry is a comprehensive, proven registry that serves as the index-of-record for deployed Web services and the business policies that affect their runtime behavior.

BEA AquaLogic® Commerce Services

BEA AquaLogic® Commerce Services can increase online sales by attracting and converting customers profitably, with the flexibility to quickly adapt sales tactics.

Customers

The total number of customers and end users of our products and solutions is greater than 16,000 worldwide. For a breakdown of our revenues by geographical region, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Revenues by Geographic Region.” Our target end-user customers are organizations with sophisticated, high-end information systems with numerous, often geographically-dispersed users and diverse computing environments. Typical customers are mainframe-reliant, have large-scale client/server implementations that handle very high volumes of business transactions, or have Web-based applications with large and unpredictable usage volumes. No customer accounted for more than 10 percent of total revenues in any of the fiscal years 2007, 2006 or 2005.

A representative list of BEA customers includes:

Telecommunications

AT&T, British Telecom, BT Global Services, Cablecom, China Telecom, ChungHwa Telecom, Comcast, Comindico, Covad, Cox Communications, Dacom, Deutsche Telekom, Dish Networks, France Telecom, KDDI Corporation, mm02, Nextel, NTT, Orange, OZ, Telecom Personal, Telicom Italia, Telecom Italia Mobile, Telenor Mobile, Telstra, TIM Peru, Verizon, Virgin Mobile USA, Visage Mobile, Vodafone, and WilTel Communications.

Banking and Financial Services

Abbey National, ABN AMRO, Accredited Home Lenders, Allstate, AXA, Bank of America, Bank of China, Bank of New York, Bank of Shanghai, Barclays, Bear Stearns, BNP Paribas, China Construction Bank, Citigroup, Credit Agricole, Credit Suisse, E*Trade, Emirates Bank, Erste Bank, Fannie Mae, First Franklin, Freddie Mac, HVB Systems, JPMorgan Chase, Lehman Brothers, Merrill Lynch, Metlife, New York Board of Trade, Nordea, Northern Trust, OppenheimerFunds, Prudential UK, Robeco Direct, SanPaolo IMI, SBAB, S.W.I.F.T., Samsung Securities, TeleCash, TrueCredit, TrueLink, and Wells Fargo.

Government

China Post, Defense Information Systems Agency, Finland Post, Grants.gov, General Services Administration, Jefferson County, Le Forem, Modus Operandi, National Education Association, Poste Italiane, UK Companies House, UK Driving Vehicle Licensing Agency, UK HM Customs & Excise, UK Inland Revenue, US Army, US Bureau of Labor & Statistics, US Defense Logistics Agency, US Department of Defense, US Federal Bureau of Investigation, US Federal Communications Commission, US General Services Administration, US Navy, and US Veterans Benefits Association.

 

13


Table of Contents

Retail and Consumer Packaged Goods

Amazon.com, Anheuser-Busch, Archer Daniels Midland, AutoNation, Barnes & Noble, Beer.com, Best Buy, Bestfoods, BonusPrint, Circuit City Group, Coca-Cola, eBay, Fuji PhotoFilm, Hijos de Rivera, Interbrew, J Sainsbury, Japan Tobacco, Kellogg, Kohl’s, L’Oreal, Nestle, Nike, Office Depot, OfficeMax, PepsiCo, Philip Morris, Priceline.com, Procter & Gamble, Rubric, R.J. Reynolds Tobacco, Saks, Staples, Suntory, Target Corporation, Ticketmaster Online-CitySearch, Tricon Global Restaurants, Tyson Foods, Unilever, Walgreens and Winn-Dixie Stores.

Manufacturing

BMW Group, Boeing, DaimlerChrysler, Daewoong Pharmaceutical, Hewlett-Packard, Network Appliance, Oncology Therapeutics Network, Pfizer, Sun Chemical, Sun Microsystems, Toshiba American Business Solutions, and Toyota Australia.

Transportation, Travel and Logistics

Amadeus, APL, Asiana Airlines, Avis, British Airways, DHL Deutsche Post World Net, FedEx, Hotelzon, Jeppessen, Lufthansa Technik, Marriott, National Car Rentals, Northwest Airlines, Schiphol Airport, SNCF, Star Alliance, Starwood Hotels & Resorts, Toll Holdings, Turkish Airlines, Union Pacific, United Airlines, UPS, and USF.

Sales, Services and Marketing

Our sales strategy is to pursue opportunities worldwide, within large organizations and organizations that are automating business processes or adopting service-oriented architectures, primarily through our direct sales, services and technical support organizations. This direct sales strategy is complemented by indirect sales channels such as distributors, value-added resellers (“VARs”), hardware original equipment manufacturers (“OEMs”), independent software vendors (“ISVs”), application service providers (“ASPs”) and systems integrators (“SIs”).

Direct Sales Organization. We market our software and services primarily through our direct sales organization. As of January 31, 2007, we had 2,569 employees in consulting, training, sales, support and marketing, including 640 quota-bearing sales representatives, located in 81 offices in 37 countries. We typically use a consultative sales model that involves the collaboration of technical and sales personnel to formulate proposals to address specific customer requirements, often in conjunction with hardware, software and services providers. Our products are typically used as a platform for initiatives and applications that are critical to a customer’s business. As such, we focus our initial sales efforts on senior executives and information technology department personnel who are responsible for such initiatives and applications.

Targeting Developers. We also market our software directly to system, application and integration developers. We make developer copies of our tools and products available for free download at our Web site. In addition, we periodically provide developer training and trial licenses through technical seminars in various locations worldwide, including on-site at our larger customers. These licenses are restricted use and include limited technical support options. We also maintain a Developers’ Website, which is designed to create a community among developers who use our products. The Developers’ Website provides a forum to exchange technical information and sample code, as well as feedback to us on our products and industry directions that we should pursue.

Strategic Relations. An important element of our sales and marketing strategy is to expand our relationships with third parties and strategic partners to increase the market awareness, demand and acceptance of BEA and our solutions. Partners have often generated and qualified sales leads, made initial customer contacts, assessed

 

14


Table of Contents

needs, recommended use of our solutions prior to our introduction to the customer, and introduced us at high levels within the customer organization. In many cases, BEA and one or more partners coordinate to make a joint proposal to potential customers. In some cases, we engage in joint account planning with our strategic partners. A strategic partner can provide customers with additional resources and expertise, especially in vertical or geographic markets in which the partner has expertise, to help meet customers’ system definition and application development requirements. Types of strategic partnerships include:

System platform companies. Customers use our software on a wide variety of hardware and operating systems. We certify our product on many different systems, and in some cases we work jointly with our partners to optimize our products on the partner’s technology. In some cases, our system platform partners act as resellers of our products, either under the BEA product name or integrated with the platform vendor’s own products. In some cases, our system platform partners co-sell BEA products and recommend our products to their customers and prospects. In particular, since July 2001, BEA and Intel have been jointly working to optimize our technology on Intel chip sets and jointly working on sales opportunities, both directly to Intel’s customers and with Intel’s system platform partners. Other system platform partners include HP and Sun Microsystems.

Packaged software vendors. We license our software to packaged software vendors. These vendors build on our software as an infrastructure for the applications they supply, or build complementary technologies, such as systems management, content management and security software, designed to connect easily to systems built on our software. Using our products as an infrastructure helps improve these applications’ reliability, scalability and portability across hardware operating systems and databases on which our platform runs. In addition, by using our infrastructure, it is easier for these vendors’ customers to integrate their packaged software with other packaged or custom applications built using our solutions. In some cases, these vendors bundle our infrastructure with their applications, and in other cases their software is simply certified to run on our infrastructure. In some cases, these vendors buy and maintain the necessary hardware, infrastructure software and application software, and rent access to these systems to their customers. Examples of packaged software partners include Amdocs, EMC Documentum, Motive, AmberPoint, BMC, Business Objects, Ceon, COMARCH, CA, Convergys, Fundtech, Intec Billing, Interwoven, iRise, Jacada, Kapow Technologies, MobileAware, RSA Security, SAS, SunGard, and Verisign.

Services partners. In many cases, customers use our software as the platform for custom applications. Often, these customers hire systems integrators or other consultants to help them design, write and implement custom systems. In some cases, our services partners have sufficient training and expertise to serve the customers’ needs without our involvement. In many cases, our sales, technical and consulting teams work with our services partners to accomplish custom projects. Examples of services partners include Accenture, Bearing Point, Capgemini, CSC, Deloitte, EDS, Infosys, Tata Consultancy Services, and Wipro.

Distributors and Resellers. To supplement the efforts of our direct sales force, we use software distributors and resellers to market, distribute, resell and support our products and services. Distributors sell directly to customers, and also cultivate, manage, supply and support a network of value-added resellers. We primarily use distributors and resellers to supplement the efforts of our direct sales force in territories where we have little direct presence, in territories where it is customary for customers to do business with a local entity and in market segments where we believe partners can expand our opportunities. Examples of distributor and reseller partners include Arrow ECS, Arsena Solusindo, Avnet Technology Solutions, Digital China Technology Limited, Itochu Techno-Science Corp CTC, Karin Electronics Supplies, NEC, Nihon Unisys, Oki Electric Industry, and Redington India.

 

15


Table of Contents

Services. We believe that our services organization plays an important role in facilitating initial license sales and enabling customers to architect, design, develop, deploy and manage systems and applications successfully. Our services revenue comes from customer support and maintenance fees, as well as fees for consulting and training services.

Customer Support. BEA offers support via telephone, Web, e-mail and fax. Our support is available 24 hours per day, with support centers located around the world. We offer enhanced, mission-critical support, which may include features such as priority-call-response, personalized case monitoring and escalation management, release/patch management planning and training on best practices. Fees for customer support are generally charged on an annual basis and vary by the level of support the customer chooses. In addition, customer support fees entitle the customer to unspecified product upgrades and maintenance updates on a when and if-available basis.

Consulting Services. Our services organization works directly with end user customers and also with our services partners, to provide a variety of consulting services. Consulting services that we offer include application development, application migration, integration, architectural assessment and architectural validation. Consulting services generally do not involve customization of the core software products licensed and are not essential to the functionality of the software. Fees for consulting services are generally charged on a time and materials basis and vary depending upon the nature and extent of services to be performed.

Education Services. We offer introductory and advanced classes and training programs on the use of BEA products which are designed for end user customers, SIs and packaged application developers. We also offer a certification program, and we are a sponsor member of jCert. The jCert initiative was created to establish and promote industry standards for certification of enterprise developers using Java technology. Our training and certification programs are offered at our offices, customer sites and training centers worldwide, as well as over the Internet. In addition, we offer a mentoring program as a follow-on to our training programs or as an approach to customized training. Fees for education services are generally charged on a per-class or per-engagement basis.

Marketing. Our marketing efforts are directed at broadening the demand for BEA products and solutions by increasing awareness of the benefits of using our products to build mission-critical distributed and Web-based applications. Marketing efforts are also aimed at supporting our worldwide direct and indirect sales channels. Marketing personnel engage in a variety of activities including conducting public relations and product seminars, issuing newsletters, sending direct mailings, preparing sales collateral and other marketing materials, coordinating our participation in industry trade shows, programs and forums, and establishing and maintaining relationships with recognized industry analysts and press. Our senior executives are frequent speakers at industry forums in many of the major markets we serve.

Competition

The market for application server, integration and SOA software, and related software infrastructure, and specialty applications in communications, time and event driven, real-time and virtualization products and services is highly competitive. Our competitors are diverse and offer a variety of solutions directed at various segments of this marketplace.

Our competitors include several companies, such as IBM, Oracle Corporation, SAP AG and Microsoft, which compete in a number of our product lines. All of these competitors have longer operating histories; significantly greater financial, technical, marketing and other resources; significantly greater name recognition; a broader product offering; a larger installed base of customers than we do; and are able to bundle competing products with their other software offerings at a discounted price. In addition, many competitors have well-established relationships with our current and potential customers. As a result, these competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the development, promotion and sale of their products than we can.

 

16


Table of Contents

In addition, current and potential competitors may make strategic acquisitions or establish cooperative relationships among themselves or with third parties, thereby increasing the ability of their products to address the needs of their current and prospective customers. Further, new competitors, or alliances among current and new competitors, may emerge and rapidly gain significant market share. Such competition could materially adversely affect our ability to sell additional software licenses and maintenance, consulting and support services on terms favorable to us.

Further, competitive pressures and open source availability of functionally competitive software could require us to reduce the price of our products and related services, which could harm our business. We may not be able to compete successfully against current and future competitors, and any failure to do so would harm our business.

Product Development

Our total research and development expenses were approximately $233.0 million, $182.2 million and $146.9 million in fiscal 2007, 2006 and 2005, respectively. Research and development expenses consist primarily of salaries and benefits for software engineers, contract development fees, costs of computer equipment used in software development, information technology and facilities expenses. The 28% increase in research and development expenses from fiscal 2006 to fiscal 2007 was due to increases in product development personnel and expenses associated with the development and release of several new products and product versions, in particular WebLogic® Server 9.0, the WebLogic® Communications Platform and the AquaLogic® product family, as well as the acquisition of several companies engaged in research and development activities. We believe that a significant level of research and development is required to remain competitive, and we expect to continue to commit substantial resources to product development and engineering in future periods.

Intellectual Property and Licenses

Our success depends upon our proprietary technology. We rely on a combination of patent, copyright, trademark and trade secret rights, confidentiality procedures and licensing arrangements to establish and protect our proprietary rights. It is possible that other companies could successfully challenge the validity or scope of our patents and that our patents may not provide a competitive advantage to us. As part of our confidentiality procedures, we generally enter into non-disclosure agreements with our employees, distributors and corporate partners and into license agreements with respect to our software, documentation and other proprietary information. Despite these precautions, third parties could copy or otherwise obtain and use our products or technology without authorization, or develop similar technology independently. In particular, we have, in the past, provided certain hardware OEMs with access to our source code, and any unauthorized publication or proliferation of our source code could materially adversely affect our business, operating results and financial condition. It is difficult for us to police unauthorized use of our products, and although we are unable to determine the extent to which piracy of our software products exists, software piracy is a persistent problem. In addition, effective protection of intellectual property rights is unavailable or limited in certain foreign countries. The protection of our proprietary rights may not be adequate, and our competitors could independently develop similar technology, duplicate the functionality of our products, or design around patents and other intellectual property rights that we hold.

Seasonality

Our first fiscal quarter license revenues are typically lower than license revenues in the immediately preceding fourth fiscal quarter because our commission plans and other sales incentives are structured for annual performance and contain bonus provisions based on annual quotas that typically are triggered in the later quarters in a fiscal year. In addition, many of our customers begin a new fiscal year on January 1 and it is common for capital expenditures to be lower in an organization’s first quarter than in its fourth quarter. We anticipate that the negative impact of seasonality on our first fiscal quarter results will continue. Our cash flows and deferred revenue balances also tend to fluctuate seasonally based in-part on the seasonality of our license business.

 

17


Table of Contents

Due to the seasonality of license revenue, a greater than proportional amount of our customer support contracts are renewed in the fourth quarter, which leads to a significant increase in deferred customer support revenue in the fourth quarter. The recognition of this deferred revenue occurs over the following four quarters and consequently deferred support revenue generally declines in the first three quarters of the next fiscal year. Due to the significant increase in deferred customer support revenue balance in the fourth quarter, there is a greater than proportional cash collection of the respective receivables that occurs in the fourth quarter and the first quarter of the following fiscal year. Consequently operating cash flow is seasonally strong in the fourth quarter and first quarter and weaker in the second and third quarters of a fiscal year.

Backlog

Our aggregate backlog at January 31, 2007 was $500 million of which $449 million is included on our balance sheet as deferred revenue. Deferred revenue, as of January 31, 2007, was comprised of (1) unexpired customer support contracts of $412 million, (2) undelivered consulting and education orders of $23 million and (3) license orders that have shipped but have not met revenue recognition requirements of $14 million. Off balance sheet backlog, which represents an operating measure, was comprised of services orders received and not delivered of $41 million and license orders received but not shipped of $10 million. Our off balance sheet backlog is not subject to our normal accounting controls for information that is either reported in or derived from our basic financial statements.

Our aggregate backlog at January 31, 2006 was $445 million of which $379 million is included on our balance sheet as deferred revenue. Deferred revenue at January 31, 2006 was composed of (1) unexpired customer support contracts of $341 million, (2) undelivered consulting and education orders of $22 million and (3) license orders that shipped but did not met revenue recognition requirements of $16 million. Off balance sheet backlog of $66 million at January 31, 2006 was composed of services orders received and not delivered of $35 million and license orders received but not shipped of $31 million. Our off balance sheet backlog is not subject to our normal accounting controls for information that is either reported in or derived from our basic financial statements.

Management does not believe that backlog, as of any particular date, is a reliable indicator of future performance. The concept of backlog is not defined in the accounting literature, making comparisons with other companies difficult and potentially misleading. BEA typically receives and fulfills most of the orders within the quarter and a substantial portion of the orders, particularly the larger transactions, are usually received in the last month of each fiscal quarter, with a concentration of such orders in the final week of the quarter. Although it is generally our practice to promptly ship product upon receipt of properly finalized purchase orders, BEA frequently has license orders that have not shipped or have otherwise not met all the required criteria for revenue recognition. In some of these cases, BEA exercises discretion over the timing of product shipments, which affects the timing of revenue recognition for software license orders. In those cases, BEA considers a number of factors, including: the effect of the related license revenue on our business plan; the delivery dates requested by customers and resellers; the amount of software license orders received in the quarter; the amount of software license orders shipped in the quarter; the degree to which software license orders received are concentrated at the end of the quarter; and our operational capacity to fulfill software license orders at the end of the quarter. Although the amount of such license orders may vary, management generally does not believe that the amount, if any, of such license product orders at the end of a particular quarter is a reliable indicator of future performance because, as noted above, such a large portion of the revenue is concentrated at the end of the quarter.

Employees

As of January 31, 2007, we had 4,278 full-time employees, including 1,248 in research and development, 2,569 in sales, support, consulting, training and marketing, and 461 in administration. Except as provided below, none of our employees are represented by a collective bargaining agreementOf our employees, 136 in France are represented by a Works Council and Union Delegates, with whom we actively consult and agree on certain

 

18


Table of Contents

organizational and work environment matters, such as wages, hours, vacation and leave, in accordance with local law and the collective industry agreement (both of which set the minimum standards of employment regulations). In addition, 235 employees in the UK and 94 employees in Germany are represented by Employee Forums with which we actively inform and consult regarding matters such as those described above. We generally consider our relations with our employees to be good and we have never experienced a work stoppage.

Foreign Operations and Geographic Information

For a breakdown of our revenues by geographical region, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Revenues by Geographic Region” in Part II, Item 7 of this Form 10-K, the “Foreign Exchange” discussion in Item 7A, and the Notes to Consolidated Financial Statements at Note 16, “Geographic Information and Revenue by Type of Product or Service” in Part II, Item 8.

Availability of this Report

We are a Delaware corporation incorporated in January 1995. Our Internet address is www.bea.com. On our Investor Information page on this web site we post the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. All such filings on our Investor Information web page are available to be viewed on this page free of charge. Information contained on our web site is not part of this Annual Report on Form 10-K or our other filings with the Securities and Exchange Commission. We assume no obligation to update or revise any forward-looking statements in this Annual Report on Form 10-K, whether as a result of new information, future events or otherwise, unless we are required to do so by law. A copy of this Annual Report on Form 10-K is available without charge upon written request to: Investor Relations, BEA Systems, Inc., 2315 North First Street, San Jose, California 95131. All such filings are also available at the Securities and Exchange Commission Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information regarding the Public Reference Room may be obtained by calling the Securities Exchange Commission at 1-800-SEC-0330.

The Securities and Exchange Commission also maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the Securities and Exchange Commission which can be found at www.sec.gov.

 

19


Table of Contents
ITEM 1A.  RISK FACTORS.

We operate in a rapidly changing environment that involves numerous risks and uncertainties. Set forth below are some, but not all, of these risks and uncertainties, which may have a material adverse effect on our business, financial condition or results of operations, and which could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this report. Prospective and existing investors should carefully consider the following risk factors, and other risks and cautionary statements set forth in this report, in evaluating an investment in our common stock.

Risks that May Impact Future Operating Results

We have experienced in the past, and may experience in the future, significant fluctuations in our actual or anticipated revenues and operating results, which has prevented us in the past, and may prevent us in the future from meeting securities analysts’ or investors’ expectations and result in a decline in our stock price.

Our revenues have fluctuated significantly in the past and are likely to fluctuate significantly in the future, which may include declines in quarterly revenues as compared to the previous fiscal quarter and as compared to the same quarterly period in the prior fiscal year, as well as declines in annual revenues as compared to the previous fiscal year. If our revenues, operating results, earnings or future projections are below the levels expected by investors or securities analysts, our stock price is likely to decline. Moreover, even if our total revenues meet investors’ and securities analysts’ expectations, if a component of our total revenues does not meet these expectations, our stock price may decline. Our stock price is also subject to many factors outside of our control, including the substantial volatility generally associated with Internet, software and technology stocks, and broader market trends unrelated to our performance, such as the substantial declines in the prices of many such stocks from 2000 through 2003, as well as market declines related to terrorist activities and military actions.

We expect to experience significant fluctuations in our future revenues and operating results as a result of many factors, including:

 

   

difficulty predicting the size and timing of customer orders, including the rate of conversion of our forecasted sales “pipeline” into contracts, particularly as we have become more reliant on larger transactions;

 

   

our ability to develop, introduce and market, on a timely basis, new products and initiatives, such as our WebLogic Server and WebLogic Platform products, WebLogic Communications Platform products, WebLogic Time & Event Driven, Real-Time and Virtualization products, and our BEA AquaLogic, business process management (“BPM”) and service oriented architecture (“SOA”) products;

 

   

the rate of customer acceptance of our new products and products to be introduced in the future, and any order delays caused by customer evaluations of these new products;

 

   

periodic difficulties or changes in the domestic or international economic, business or political environment, particularly affecting the technology industry or industries from which we derive a significant portion of our revenues, such as the telecommunications industry, including but not limited to corporate or consumer confidence in the economy, uncertainties arising out of possible future terrorist activities, military and security actions in Iraq and the Middle East in general, and geopolitical instability such as in parts of Asia, all of which have increased the likelihood that customers will unexpectedly delay, cancel or reduce the size of orders;

 

   

the structure, timing and integration of acquisitions of businesses, products and technologies and the related disruption of our current business;

 

   

costs associated with acquisitions, including expenses charged for any impaired acquired intangible assets and goodwill;

 

20


Table of Contents
   

fluctuations in foreign currency exchange rates, which could have an adverse impact on our international revenue, particularly in EMEA, if the Euro or British Pound were to weaken significantly against the U.S. dollar;

 

   

the performance of our international business, which accounts for approximately one-half of our consolidated revenues;

 

   

changes in the mix of products and services that we sell or the channels through which they are distributed;

 

   

changes in our competitors’ product offerings, marketing programs and pricing policies, and customer order deferrals in anticipation of new products and product enhancements from us or our competitors;

 

   

any increased price sensitivity by our customers, particularly in the face of periodic uneven economic conditions and increased competition, including open source or free competitive software;

 

   

the lengthy sales cycle for our products, particularly with regard to WebLogic Communications Platform, WebLogic Platform, and Aqualogic sales, which typically involve more comprehensive solutions that may require us to provide a significant level of education to prospective customers regarding the use and benefits of our products and may result in more detailed customer evaluations, and the discretionary nature of our customers’ purchase and budget cycles;

 

   

our ability to control costs and expenses, particularly in the face of periodic difficult economic conditions;

 

   

loss of key personnel or inability to recruit and hire qualified additional or replacement key personnel;

 

   

the degree of success, if any, of our strategy to further establish and expand our relationships with distributors;

 

   

the terms and timing of financing activities;

 

   

potential fluctuations in demand or prices of our products and services;

 

   

technological changes in computer systems and environments;

 

   

our ability to meet our customers’ service requirements;

 

   

the seasonality of our sales, particularly license orders, which typically significantly adversely affects our revenue in our first quarter; and

 

   

takeover speculation related specifically to us or to consolidation in the software industry generally.

Our quarterly revenues, expenses and operating results are difficult to forecast because of the volatility of our license revenues.

A substantial portion of our license revenues have been derived from large orders. Reliance on large license transactions increases the risk of fluctuation in quarterly results because the unexpected loss of a small number of larger orders can create a significant revenue shortfall. If we cannot generate a sufficient number of large customer orders, convert a sufficient number of development orders into orders for large deployments, or if customers delay or cancel such orders in a particular quarter, it may have a material adverse effect on our revenues and, more significantly on a percentage basis, our net income or loss in that quarter.

We use a “pipeline” system, a common industry practice, to forecast sales and trends in our business. Our sales personnel monitor the status of all potential transactions, including the estimated closing date and estimated dollar amount of each transaction. We aggregate these estimates periodically to generate a sales pipeline and then evaluate the pipeline to forecast sales and identify trends in our business. This pipeline analysis and related estimates of revenue has in recent periods and may in future periods differ significantly from actual revenues in a particular reporting period.

 

21


Table of Contents

A slowdown in the global economy, among other factors, has caused and may continue to cause customer purchasing decisions to be delayed, reduced in amount or cancelled, all of which have reduced and could in the future reduce the rate of conversion of the pipeline into contracts.

Moreover, we typically receive and fulfill most of our orders within the quarter, and a substantial portion of our orders, particularly our larger transactions, are typically received in the last month of each quarter, with a concentration of such orders at the end of the quarter. As a result, even though we may have substantial backlog at the end of a prior quarter and positive business indicators such as sales “pipeline” reports about customer demand during a quarter, we may not learn of revenue shortfalls until very late in the quarter, and possibly not until the final day or days of the quarter. Not only could such shortfalls significantly adversely affect our revenues, they could substantially adversely affect our earnings because we may not become aware of such shortfalls in time to adjust our cost structure to respond to a variation in the conversion of the pipeline into contracts. Our inability to respond to a variation in the pipeline or in the conversion of the pipeline into contracts in a timely manner, or at all, could cause us to plan or budget inaccurately and thereby adversely affect our business, financial condition or results of operations.

Further, periodic adverse economic conditions, particularly those related to the technology industry and the economic and political uncertainties arising out of the ongoing U.S. military activity in Iraq, recent and possible future terrorist activities, other potential military and security actions in the Middle East, and instability in markets in other parts of the world, have increased the likelihood that customers will unexpectedly delay, cancel or reduce orders, resulting in revenue shortfalls.

Because of such factors and our operating history and on-going expenses associated with our prior acquisitions, the possibility of future impairment charges and the possibility of future charges related to any future facilities consolidation or work force reductions, we may again experience net losses in future periods. In addition, as we have expensed stock option grants under FAS 123R for fiscal periods commencing February 1, 2006, we will continue to have significant accounting charges that will make it substantially more likely we could experience net losses. Any revenue shortfall below our expectations or increase in expenses could have an immediate and significant adverse effect on our results of operations and lead to a net loss.

The seasonality of our sales typically has a significant adverse effect on our revenues in our first fiscal quarter.

Our first quarter revenues, particularly our license revenues, are typically lower than revenues in the immediately preceding fourth quarter. We believe this is because our commission plans and other sales incentives are structured for annual performance and contain bonus provisions based on annual quotas that typically are triggered in the later quarters in a year. In addition, most of our customers begin a new fiscal year on January 1 and it is common for capital expenditures to be lower in an organization’s first quarter than in its fourth quarter. We anticipate that the negative impact of seasonality on our first quarter will continue. Moreover, because of this seasonality, even if we have a very strong fourth quarter in a particular year, the initial quarter in the next year could nevertheless still be weak on a year-over-year comparative basis, as well as on a sequential basis. This risk remains even if the amount of our deferred revenue and backlog is substantial at the close of the immediately preceding fourth quarter. This seasonality may harm our revenues and other operating results in our first quarter and possibly subsequent quarters as well, particularly if the seasonal impact is more pronounced than we expect.

The lengthy sales cycle for our products makes our revenues susceptible to substantial fluctuations.

Many of our customers use our products to implement large, sophisticated applications that are critical to their business, and their purchases are often part of their implementation of a Web-based computing environment, or SOA. Customers evaluating our software products face complex decisions regarding alternative approaches to the integration of enterprise applications, competitive product offerings, implementation of SOA,

 

22


Table of Contents

rapidly changing software technologies and standards, and limited internal resources due to other information systems demands. For these and other reasons, the sales cycle for our products is lengthy and unpredictable, and potential orders are subject to delays or cancellation for reasons over which we have little or no control. In addition, we continue to rely on a significant number of million and multimillion dollar license transactions. In some cases, the larger size of the transactions has resulted in more extended customer evaluation and procurement processes, which in turn have lengthened the overall sales cycle for our products. Periodic economic difficulties in our key markets have also contributed to increasing the length of our sales cycle.

Finally, the introduction of AquaLogic and other products and implementation of our products for SOA have contributed to a longer sales cycle due to the fact that it offers a more comprehensive solution that may require us to provide a significant level of education to prospective customers regarding the use and benefits of our products, and may result in more detailed customer evaluations. Delays or failures to complete large orders and sales in a particular quarter could significantly reduce revenue that quarter, as well as subsequent quarters over which revenue for the sale would likely be recognized.

We have restructured, and may in the future restructure, our sales force, which can be disruptive.

We continue to rely heavily on our direct sales force. In recent years, we have restructured or made other adjustments to our sales force in response to factors such as conditions in the information technology industry, our expenses related to revenues, management changes, product changes and other external and internal considerations. Changes in the structure of the sales force and sales force management have resulted in a temporary lack of focus and reduced productivity that may have affected revenues in one or more quarters. If we continue to restructure our sales force, then the transition issues associated with restructuring the sales force may recur. Such restructuring or associated transition issues can be disruptive and adversely impact our business and operating results.

Any failure to maintain on-going sales through distribution channels could result in lower revenues, and increasing sales through distribution channels could result in lower margins on our license revenues.

To date, we have sold our products principally through our direct sales force, as well as through indirect sales channels, such as computer hardware companies, packaged application software developers, independent software vendors (“ISVs”), systems integrators (“SIs”), original equipment manufacturers (“OEMs”), consultants, software tool vendors and distributors. Our ability to achieve revenue growth in the future will depend in large part on our success in maintaining existing relationships and further establishing and expanding relationships with our indirect sales channels. In particular, we have an ongoing initiative to further establish and expand relationships with our distributors, especially ISVs and SIs. A significant part of this initiative is to recruit and train a large number of consultants employed by SIs and induce these SIs to more broadly use our products in their consulting practices, as well as to embed our technology in products that our ISV customers offer. We intend to continue this initiative and to seek distribution arrangements with additional ISVs to embed our WebLogic Server and other products in their products. It is possible that we will not be able to successfully expand our distribution channels, secure agreements with additional SIs and ISVs on commercially reasonable terms or at all, and otherwise adequately continue to develop and maintain our relationships with indirect sales channels. Moreover, even if we succeed in these endeavors, it still may not increase our revenues. In particular, we need to carefully monitor the development and scope of our indirect sales channels and create appropriate pricing, sales force compensation and other distribution parameters to help ensure these indirect channels do not conflict with or curtail our direct sales. If we invest resources in these types of expansion and our overall revenues do not correspondingly increase, our business, results of operations and financial condition will be materially and adversely affected. In addition, we already rely on formal and informal relationships with a number of SIs and consulting firms to enhance our sales, support, service and marketing efforts, particularly with respect to implementation and support of our products as well as lead generation and assistance in the sales process. Many such firms have similar, and often more established, relationships with our principal competitors. It is possible that these and other third parties will not provide the level and quality of service required to meet

 

23


Table of Contents

the needs of our customers, or that we will not be able to maintain an effective, long-term relationship with these third parties. However, because we achieve lower margins on license revenue sales through distribution channels, an increase in our sales through distribution channels could result in lower margins on our license revenues.

If we do not compete effectively with new and existing competitors, our revenues and operating margins will decline.

The market for application server, integration and SOA software, and related software infrastructure, and specialty applications in communications, time and event driven, real-time and virtualization products and services is highly competitive. Our competitors are diverse and offer a variety of solutions directed at various segments of this marketplace.

Our competitors include several companies, such as IBM, Oracle Corporation, SAP AG and Microsoft, which compete in a number of our product lines. All of these competitors have longer operating histories; significantly greater financial, technical, marketing and other resources; significantly greater name recognition; a broader product offering; a larger installed base of customers than we do; and are able to bundle competing products with their other software offerings at a discounted price. In addition, many competitors have well-established relationships with our current and potential customers. As a result, these competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the development, promotion and sale of their products than we can.

In addition, current and potential competitors may make strategic acquisitions or establish cooperative relationships among themselves or with third parties, thereby increasing the ability of their products to address the needs of their current and prospective customers. Further, new competitors, or alliances among current and new competitors, may emerge and rapidly gain significant market share. Such competition could materially adversely affect our ability to sell additional software licenses and maintenance, consulting and support services on terms favorable to us.

Further, competitive pressures and open source availability of functionally competitive software could require us to reduce the price of our products and related services, which could harm our business. We may not be able to compete successfully against current and future competitors, and any failure to do so would harm our business.

Because the technological, market and industry conditions in our business can change very rapidly, if we do not successfully adapt our products to these changes, our revenue and profits will be harmed.

The market for our products and services is highly fragmented, competitive with alternative computing architectures, and characterized by continuing technological developments, evolving and competing industry standards, and changing customer requirements. The introduction of products embodying new technologies, the emergence of new industry standards, or changes in customer requirements could result in a decline in the markets for our existing products or render them obsolete and unmarketable. As a result, our success depends upon our ability to timely and effectively enhance existing products, respond to changing customer requirements, and develop and introduce in a timely manner new products and initiatives that keep pace with technological and market developments and emerging industry standards, as well as our ability to educate and train our sales force and indirect sales channels on our new or enhanced products, initiatives and technologies. It is possible that our products will not adequately address the changing needs of the marketplace and that we will not be successful in developing and marketing enhancements to our existing products or new products on a timely basis. Failure to develop, acquire and introduce new products, or enhancements to existing products, in a timely manner in response to changing market conditions or customer requirements, or lack of customer acceptance of our products, will materially and adversely affect our business, results of operations and financial condition. In addition, our success is increasingly dependent on our strategic partners’ ability to successfully develop and integrate their software with those of our products with which their software interoperates or is bundled,

 

24


Table of Contents

integrated or marketed. If their software performs poorly, contains errors or defects or is otherwise unreliable, or does not provide the features and benefits expected or required, it could lower the demand for our products and services, result in negative publicity or loss of our reputation, and adversely affect our revenues and other operating results.

If the markets for application servers, application platforms, application integration, portal, BPM, SOA and related application infrastructure software and Web services decline or do not grow as quickly as we expect, our revenues will be harmed.

We sell our products and services in the application server, application platform, application integration, portal, BPM, SOA and related application and service infrastructure markets. These markets are characterized by continuing technological developments, evolving industry standards and changing customer requirements.

Our success is dependent in large part on acceptance of our products by large customers with substantial legacy mainframe systems, customers establishing or building out their presence on the Web for commerce, and developers of Web-based commerce applications and SOA. Our future financial performance will depend in large part on the continued growth in the use of the Web to run software applications and continued growth in the number of companies extending their mainframe-based, mission-critical applications to an enterprise-wide distributed computing environment and to the Internet through the use of application server and integration technology and SOA. The markets for application server, application platform, portal, application integration, web services, BPM and SOA and related services and technologies may not grow and could decline. Even if they do grow, they may grow more slowly than we anticipate, particularly in view of periodic economic difficulties affecting the technology sector in the United States, Asia and Europe. If these markets fail to grow, grow more slowly than we currently anticipate, or decline, our business, results of operations and financial condition will be adversely affected.

Our revenues are derived primarily from a single group of similar and related products and related services, and a decline in demand or prices for these products or services could substantially adversely affect our operating results.

We currently derive the majority of our license and service revenues from BEA WebLogic Server, Tuxedo and our AquaLogic products, and from related products and services. We expect these products and services to continue to account for the majority of our revenues in the immediate future. As a result, factors adversely affecting the pricing of or demand for BEA WebLogic Server, Tuxedo, AquaLogic products or related services, such as periodic difficult economic conditions, future terrorist activities or military actions, any decline in overall market demand, competition, product performance or technological change, could have a material adverse effect on our business and consolidated results of operations and financial condition. In particular, with regard to Tuxedo, we have recently experienced a decline in the percentage of our license revenue generated by Tuxedo, as well as a decline in the absolute dollar amount of revenue generated by Tuxedo. If this trend were to continue or worsen, it would have an adverse impact on our revenue, profit and other operating results.

Our future growth, if any, is expected to be achieved through the implementation and introduction of our new product initiatives in SOA, AquaLogic, time and event-driven architectures, real-time applications, virtualization, and WebLogic Communications Platform. Many of these new product initiatives have substantial, entrenched competitors with greater resources and experience in these product areas. Other product initiatives are in nascent markets, and it is unclear when or if these markets will develop into substantial markets or whether we will serve those markets well. There can be no assurances that all or any of these new products will be successful and contribute to profitability or growth.

 

25


Table of Contents

If our WebLogic Communications Platform, AquaLogic and other recently introduced products do not achieve significant market acceptance, or market acceptance is delayed, our revenues will be substantially adversely affected.

In January 2006 we released the first product of our WebLogic Communications Platform. In June 2006, we introduced the BEA AquaLogic group of products and enhanced them with products from the Plumtree acquisition for our SOA offerings. We have invested substantial resources to develop, acquire and market these products, and anticipate that this will continue. If these products and our other products currently in development do not achieve substantial market acceptance among new and existing customers, whether due to factors such as any technological problems, competition, pricing, sales execution, market shifts or otherwise, it will have a material adverse effect on our revenues and other operating results. Moreover, because our new products generally offer broader solutions and other improvements over our prior products, potential customers may take additional time to evaluate their purchases, which can delay customer acceptance of our new products. If these delays continue or worsen, it will adversely affect our revenues and other operating results.

If we fail to adequately protect our intellectual property rights, competitors may use our technology and trademarks, which could weaken our competitive position, reduce our revenues and increase our costs.

Our success depends upon our proprietary technology. We rely on a combination of patent, copyright, trademark and trade secret rights, confidentiality procedures and licensing arrangements to establish and protect our proprietary rights. It is possible that other companies could successfully challenge the validity or scope of our patents and that our patents may not provide a competitive advantage to us.

As part of our confidentiality procedures, we generally enter into non-disclosure agreements with our employees, distributors and corporate partners and into license agreements with respect to our software, documentation and other proprietary information. Despite these precautions, third parties could copy or otherwise obtain and use our products or technology without authorization, or develop similar technology independently. In particular, we have in the past provided certain hardware OEMs with access to our source code, and any unauthorized publication or proliferation of our source code could materially adversely affect our business, operating results and financial condition. It is difficult for us to police unauthorized use of our products, and although we are unable to determine the extent to which piracy of our software products exists, software piracy is a persistent problem. In addition, effective protection of intellectual property rights is unavailable or limited in certain foreign countries. The protection of our proprietary rights may not be adequate, and our competitors could independently develop similar technology, duplicate our products, or design around patents and other intellectual property rights that we hold.

Third parties could assert that our software products and services infringe their intellectual property rights, which could expose us to increased costs and litigation.

We have been and continue to be subject to legal proceedings and claims that arise in the ordinary course of our business, including claims currently being asserted that our products infringe certain patent rights. It is possible that third parties, including competitors, technology partners and other technology companies, could successfully claim that our current or future products, whether developed internally or acquired, infringe their rights, including their trade secret, copyright and patent rights. These types of claims, with or without merit, can cause costly litigation that requires significant management time, as well as impede our sales efforts due to any uncertainty as to the outcome, all of which could materially adversely affect our business, operating results and financial condition. These types of claims, with or without merit, could also cause us to pay substantial damages or settlement amounts, cease offering any subject technology or products altogether, require us to enter into royalty or license agreements, compel us to license software under unfavorable terms, and damage our ability to sell products due to any uncertainty generated as to intellectual property ownership. If required, we may not be able to obtain such royalty or license agreements, or obtain them on terms acceptable to us, which could have a material adverse effect upon our business, operating results and financial condition, particularly if we are unable to ship key products.

 

26


Table of Contents

If our products contain software defects, it could harm our revenues and expose us to litigation.

The software products we offer are internally complex and, despite extensive testing and quality control, may contain errors or defects, especially when we first introduce them. We may need to issue corrective releases of our software products to fix any defects or errors. Any defects or errors could also cause damage to our reputation and result in loss of revenues, product returns or order cancellations, lack of market acceptance of our products, or increased service and warranty costs. Accordingly, any defects or errors could have a material and adverse effect on our business, results of operations and financial condition.

Our license agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims. It is possible, however, that the limitation of liability provisions contained in our license agreements may not be effective as a result of existing or future federal, state or local laws or ordinances or unfavorable judicial decisions. Although we have not experienced any product liability claims to date, sale and support of our products entails the risk of such claims, which could be substantial in light of our customers’ use of such products in mission-critical applications. If a claimant brings a product liability claim against us, it could have a material adverse effect on our business, results of operations and financial condition. Our products interoperate with many parts of complicated computer systems, such as mainframes, servers, personal computers, application software, databases, operating systems and data transformation software. Failure of any one of these parts could cause all or large parts of computer systems to fail. In such circumstances, it may be difficult to determine which part failed, and it is likely that customers will bring a lawsuit against several suppliers. Even if our software is not at fault, we could suffer material expense and material diversion of management time in defending any such lawsuits.

If we do not maintain our relationships with third-party vendors, interruptions in the supply of our products may result.

Portions of our products incorporate software that was developed and is maintained by third-party software vendors. We may not be able to replace the functionality provided by the third-party software currently offered with our products if that software becomes obsolete or incompatible with future versions of our products or is not adequately maintained or updated. Any significant interruption in the supply of these products could adversely impact our sales unless and until we can secure another source at costs which are acceptable to us. We depend in part on these third parties’ abilities to enhance their current products, to develop new products on a timely and cost-effective basis and to respond to emerging industry standards and other technological changes. The inability to replace, or any significant delay in the replacement of, functionality provided by third-party software in our products could materially and adversely affect our business, financial condition or results of operations.

Our international operations expose us to greater management, collections, currency, export licensing, intellectual property, tax, regulatory and other risks.

Revenues from markets outside of the Americas has accounted for approximately one-half of our total revenues over the past several years, and we expect these markets to continue to account for a significant portion of our total revenues. We sell our products and services through a network of branches and subsidiaries located in 37 countries worldwide. In addition, we also market our products through distributors. We believe that our success depends upon continued expansion of our international operations. Our international business is subject to a number of risks, including greater difficulties in maintaining and enforcing U.S. accounting and public reporting standards, greater difficulties in staffing and managing foreign operations with personnel sufficiently experienced in U.S. accounting and public reporting standards, unexpected changes in regulatory practices and tariffs, longer collection cycles, seasonality, potential changes in export licensing and tax laws, and greater difficulty in protecting intellectual property rights. Also, the impact of fluctuating exchange rates between the U.S. dollar and foreign currencies in markets where we do business can significantly impact our revenues. The EMEA region has historically accounted for, and we expect in the future will continue to account for, a significant portion of our revenues. If the value of the U.S. dollar relative to European currencies were to significantly increase, it would have an adverse impact on our revenues, profits and other operating results. Also,

 

27


Table of Contents

we are periodically subject to tax audits by government agencies in foreign jurisdictions. To date, the outcomes of these audits have not had a material impact on us. It is possible, however, that future audits could result in significant assessments against us or our employees for transfer taxes, payroll taxes, income taxes, or other taxes as well as related employee and other claims which could adversely effect our operating results. General economic and political conditions in these foreign markets, including the military action in the Middle East, geopolitical instabilities in other parts of the world and a backlash against U.S. based companies may also impact our international revenues, as such conditions may cause decreases in demand or impact our ability to collect payment from our customers. There can be no assurances that these factors and other factors will not have a material adverse effect on our future international revenues and consequently on our business and consolidated financial condition and results of operations.

Changes in accounting regulations and related interpretations and policies, particularly those related to accounting for stock options and revenue recognition, could cause us recognize lower revenue and profits or to defer recognition of revenue.

The methods, estimates, and judgments we use in applying our accounting policies have a significant impact on our results of operations. Such methods, estimates, and judgments are, by their nature, subject to substantial risks, uncertainties, and assumptions, and factors may arise over time that lead us to change our methods, estimates, and judgments. Changes in those methods, estimates, and judgments could significantly affect our results of operations. For example, the FASB has adopted Financial Accounting Standards Board Statement No. 123R (“FAS 123R”), Share-Based Payment, replacing FAS 123, which eliminates the ability to account for compensation transactions using Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and requires that such transactions be accounted for using the fair value based method.

The fair value based method of accounting for compensation transactions required under FAS 123R requires the use of valuation methodologies which were developed for valuing traded options, not employee stock options and restricted stock units, and requires a number of assumptions, estimates and conclusions regarding complex and subjective matters such as the expected forfeitures of equity awards, the expected volatility of our stock price, the expected dividend rate with respect to our common stock, and the exercise behavior of our employees. Because our employee stock options have certain characteristics that are significantly different from traded options, and because changes in the subjective assumptions can materially affect the estimated value, the existing valuation models may not provide an accurate measure of the fair value of our employee stock options. In addition, these factors may be difficult to analyze. Therefore, it is possible that the attribution of this non-cash charge may be misunderstood and cause increased volatility in our stock price. Similarly, factors may arise over time that lead us to change our estimates and assumptions with respect to future share-based compensation arrangements, resulting in variability in our share-based compensation expense over time. Changes in forecasted share-based compensation expense could impact our gross margin percentage; research and development expenses; marketing, general and administrative expenses; and our tax rate. In accordance with FAS 123R, we have expensed stock options granted in fiscal periods commencing February 1, 2006 using the fair value method. For example, for the year ended January 31, 2007 we accounted for stock-based compensation under FAS 123R and diluted earnings per share were reduced by $0.10 per share. Had we accounted for stock-based compensation plans under Financial Accounting Standards Board (“FASB”) Statement No. 123, as amended by FASB Statement No. 148, diluted earnings per share for the years ended January 31, 2006 and 2005 would have been reduced by $0.18 and $0.21 per share, respectively.

Similarly, although we use standardized license agreements designed to meet current revenue recognition criteria under generally accepted accounting principles, we must often negotiate and revise terms and conditions of these standardized agreements, particularly in larger license transactions. Negotiation of mutually acceptable terms and conditions can extend the sales cycle and, in certain situations, may require us to defer recognition of revenue on the license. While we believe that we are in compliance with Statement of Position 97-2, Software Revenue Recognition, as amended, the American Institute of Certified Public Accountants continues to issue implementation guidelines for these standards and the accounting profession continues to discuss a wide range of

 

28


Table of Contents

potential interpretations. Additional implementation guidelines, and changes in interpretations of such guidelines, could lead to unanticipated changes in our current revenue accounting practices that could cause us to defer the recognition of revenue to future periods or to recognize lower revenue and profits.

Moreover, policies, guidelines and interpretations related to revenue recognition, accounting for acquisitions, income taxes, facilities consolidation charges, allowances for doubtful accounts and other financial reporting matters require us to make difficult judgments on complex matters that are often subject to multiple sources of authoritative guidance. To the extent that our judgment is incorrect, it could result in an adverse impact on the Company’s financial statements. Some of these matters are also among topics currently under re-examination by accounting standard setters and regulators. These standard setters and regulators could promulgate interpretations and guidance that could result in material and potentially adverse changes to our accounting policies.

Unanticipated changes in our effective tax rates or exposure to additional income tax liabilities could affect our profitability.

We are a U.S. based multinational company subject to tax in multiple U.S. and foreign tax jurisdictions. Our provision for income taxes is based on jurisdictional mix of earnings, statutory rates, and enacted tax rules, including transfer pricing. Significant judgment is required in determining our provision for income taxes and in evaluating our tax positions on a worldwide basis. It is possible that these positions may be challenged which may have a significant impact on our effective tax rate.

If we are unable to manage our growth, our business will suffer.

We have experienced substantial growth since our inception in 1994. Overall, we have increased the number of our employees from 120 employees in three offices in the United States at January 31, 1996 to approximately 4,278 employees in 81 offices in 37 countries at January 31, 2007. Our ability to manage our staff and growth effectively requires us to continue to improve our operational, financial, disclosure and management controls, reporting systems and procedures, and information technology infrastructure, particularly in light of the enactment of the Sarbanes-Oxley Act of 2002 and related regulations.

In this regard, we are continuing to update our management information systems to integrate financial and other reporting among our multiple domestic and foreign offices. In addition, we may continue to increase our staff worldwide and continue to improve the financial reporting and controls for our global operations. We are also continuing to develop and roll out information technology initiatives. It is possible that we will not be able to successfully implement improvements to our management information, control systems, reporting systems and information technology infrastructure in an efficient or timely manner and that, during the course of this implementation, we could discover deficiencies in existing systems and controls, as well as past errors resulting there from. If we are unable to manage growth effectively, our business, results of operations and financial condition will be materially adversely affected.

The majority of our expenses are personnel-related costs such as employee compensation and benefits, along with the cost of the infrastructure (occupancy and equipment) to support our employee base. The failure to adjust our employee base to the appropriate level to support our revenues could materially and adversely affect our business, operating results and financial condition.

We may lose key personnel or may not be able to hire enough qualified personnel, which would adversely affect our ability to manage our business, develop and acquire new products and increase revenue.

We believe our future success will depend upon our ability to attract and retain highly skilled personnel, including members of management and key technical employees. Competition for these types of employees is intense, and it is possible that we will not be able to retain our key employees and that we will not be successful

 

29


Table of Contents

in attracting, assimilating and retaining qualified candidates in the future. In addition, as we seek to expand our global organization, the hiring of qualified sales, technical and support personnel has been, and will continue to be, difficult due to the limited number of qualified professionals. Failure to attract, assimilate and retain key personnel would have a material adverse effect on our business, results of operations and financial condition.

We have historically used stock options and other forms of equity compensation as key components of our employee compensation program in order to align employees' interests with the interests of our stockholders, encourage employee recruitment and retention, and provide competitive compensation packages. The changing regulatory landscape, including as a result of FAS 123R, could make it more difficult and expensive for us to grant stock options to employees in the future, and require us to modify our equity granting strategy, including reducing the level of equity awards we grant. If employees believe that the incentives that they would receive under a modified strategy are less attractive, we may find it difficult to attract, retain and motivate employees. In addition, the use of alternative equity incentives may increase our compensation expense and may negatively impact our earnings. To the extent that new regulations make it more difficult or expensive to grant equity instruments to employees, we may incur increased compensation costs, further change our equity compensation strategy or find it increasingly difficult to attract, retain and motivate employees, each of which could materially and adversely affect our business, financial condition or results of operations.

If we cannot successfully integrate our past and future acquisitions, our revenues may decline and expenses may increase.

From our inception in January 1994, we have made a substantial number of strategic acquisitions. From June 2005 to August 2006, we acquired Plumtree Software, Inc., a publicly traded software company, as well as six smaller companies in targeted cash acquisitions, each of which has presented an integration challenge to our business operations. In addition, integration of acquired companies, divisions and products involves the assimilation of potentially conflicting products and operations, including the maintenance of effective internal controls, which diverts the attention of our management team and may have a material adverse effect on our operating results in future quarters. It is possible that we may not achieve any of the intended financial or strategic benefits of these transactions. Further, while we may desire to make additional acquisitions in the future, there may not be suitable companies, divisions or products available for acquisition. Our acquisitions entail numerous risks, including the risk that we will not successfully assimilate the acquired operations and products, retain key employees of the acquired companies, or execute successfully the strategy driving the acquisition. There are also risks relating to the diversion of our management’s attention, and difficulties and uncertainties in our ability to maintain the key business relationships that we or the acquired companies have established. In addition, we may have product liability or intellectual property liability associated with the sale of the acquired company’s products.

Acquisitions also expose us to the risk of claims by terminated employees, shareholders of the acquired companies or other third parties related to the transaction. Finally, if we undertake future acquisitions, we may issue dilutive securities, assume or incur additional debt obligations, incur large one-time expenses, utilize substantial portions of our cash, and acquire intangible assets that would result in significant future amortization expense. Any of these events could have a material adverse effect on our business, operating results and financial condition.

On June 29, 2001, the FASB pronounced under Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“FAS 142”), that purchased goodwill should not be amortized, but rather, should be periodically reviewed for impairment. Such impairment could be caused by internal factors as well as external factors beyond our control. The FASB has further determined that at the time goodwill is considered impaired, an amount equal to the impairment loss should be charged as an operating expense in the statement of income. The timing of such an impairment (if any) of goodwill acquired in past and future transactions is uncertain and difficult to predict. If future events cause additional impairment of any intangible assets acquired in our past or future acquisitions, we may have to record additional charges relating to such assets

 

30


Table of Contents

sooner than we expect which would cause our profits to decline. We are required to determine whether goodwill and any assets acquired in past acquisitions have been impaired in accordance with FAS 142 and, if so, charge such impairment as an expense. For example, in the quarter ended October 31, 2001, we took an asset impairment charge of $80.1 million related to past acquisitions. At January 31, 2007, we had remaining net goodwill and net acquired intangible assets of approximately $301.9 million. In the quarter ended April 30, 2007, we took an additional charge of approximately $3.8 million in connection with impairment of goodwill related to our acquisition of Connectera. If we are required to take such additional impairment charges, the amounts could have a material adverse effect on our results of operations.

We face risks in connection with Plumtree’s government contracts which may adversely affect our results of operations.

We face risks associated with the businesses and operations of Plumtree, which we acquired on October 20, 2005. Plumtree derived a significant portion of its software license and service revenue from government customers. We have assumed Plumtree’s business with the United States government and other domestic and international public entities, including the risks associated with such business, such as the susceptibility to unpredictable governmental budgetary and policy changes. Sales to government entities can be adversely affected by budgetary cycles, changes in policy and other political events outside of our control, such as the outbreak of hostilities overseas and domestic terrorism. Governments often retain the ability to cancel contracts at their convenience in times of emergency or under other circumstances. Some of Plumtree’s government customers have experienced budgetary constraints due to decreased federal funding to state and local governments. Additionally, the government may require special intellectual property rights and other license terms generally more favorable to the customer than those typical in non-government contracts. These requirements involve more licensing cost and increased contract risk for us. The government procurement process in general can be long and complex and being a government vendor subjects us to additional regulations.

In addition, we have conducted an initial internal investigation into Plumtree’s compliance with, and we are subject to an ongoing review in relation to, Plumtree’s contract with the U.S. General Services Administration (“GSA”) which may adversely impact our financial position, liquidity and results of operations. The U.S. government often retains the right to audit its vendors for compliance. In February 2005, Plumtree became aware that in connection with certain sales made under its GSA contract, Plumtree may not have complied fully with the terms of the “Price Reductions” clause of such contract. As a result, Plumtree voluntarily offered the GSA a temporary price reduction. In response, Plumtree was informed that the matter would be considered further within the GSA. Plumtree commenced an internal investigation into this matter in the second quarter of 2005 and, with the assistance of special legal counsel and forensic accountants, concluded that a damage payment or future discounts off of the GSA price list might be due to the GSA under the GSA contract pursuant to the “Price Reductions” clause. In the quarter ended June 30, 2005, Plumtree established a $1.5 million contingent contract reserve for the potential damage payment or future discounts off the GSA price list related to the GSA contract matter. BEA has reviewed the results of the internal investigation and based on our assessment we have recorded $1.5 million as the fair value of the contingency as of October 20, 2005. In January 2006, we completed this self-audit, which was consistent with the original assessment, and reported these results to the GSA. The GSA has indicated that it would like us to perform an additional review of the period from March 31, 2005 through June 30, 2005. We are currently assessing the GSA’s desire for this additional period. However we have not commenced such additional review and have not recorded any additional contingency accruals related to this issue as of January 31, 2007. There has been no communication from the GSA since April 2006. The final amount of the potential contract damages or future discounts off of the GSA price list is subject to the outcome of final resolution with the GSA. It is possible that the final settlement could exceed the reserve and have a material impact on our financial position, liquidity and results of operations. It is also possible that the GSA may elect to take other action, such as an audit of Plumtree’s compliance with the terms of the applicable GSA contract. Any such audit could prove costly and may distract our management. In addition, as a result of such audit, the U.S. government may require a further discount on future orders under the GSA contract, or seek other remedies. Any such action may adversely affect our financial position, revenue, liquidity and results of operations.

 

31


Table of Contents

Some provisions in our certificate of incorporation and bylaws, as well as a stockholder rights plan, may have anti-takeover effects.

We have a stockholder rights plan providing for one right for each outstanding share of our common stock. Each right, when exercisable, entitles the registered holder to purchase certain of our securities at a specified purchase price. The rights plan my have the anti-takeover effects of causing substantial dilution to a person or group that attempts to acquire us on terms not approved by our Board of Directors. The existence of the rights plan could limit the price that certain investors might be willing to pay in the future for shares of our common stock and could discourage, delay or prevent a merger or acquisition that stockholders may consider favorable. In addition, provisions of our current certificate of incorporation and bylaws, as well as Delaware corporate law, could make it more difficult for a third party to acquire us without the support of our Board of Directors, even if doing so would be beneficial to our stockholders.

The ongoing U.S. military activity in Iraq and any terrorist activities could adversely affect our revenues and operations.

The U.S. military activity in Iraq, terrorist activities and related military and security operations have in the past disrupted economic activity throughout the United States and much of the world. This significantly adversely impacted our operations and our ability to generate revenues in the past and may again in the future. An unfavorable course of events in the future related to the ongoing U.S. military activity in Iraq; any other military or security operations, particularly with regard to the Middle East; any future terrorist activities; or geopolitical tension in other parts of the world could have a similar or worse effect on our operating results, particularly if such attacks or operations occur in the last month or weeks of our quarter or are significant enough to further weaken the U.S. or global economy. In particular, such activities and operations could result in reductions in information technology spending, order deferrals, and reductions or cancellations of customer orders for our products and services.

An unfavorable government review of our income and payroll tax returns or changes in our effective tax rates could adversely affect our operating results.

Our operations are subject to income, payroll and indirect taxes in the United States and in multiple foreign jurisdictions. We exercise judgment in determining our worldwide provision for these taxes, and in the ordinary course of our business there may be transactions and calculations where the ultimate tax determination is uncertain.

Our U.S. federal income tax returns for 2005 through 2006 fiscal years are currently under examination by the IRS. In addition, certain of our U.S. payroll tax returns (primarily related to taxes associated with stock option exercises), and various state and foreign tax returns are under examination by the applicable taxing authorities. While we believe that we have made adequate provisions related to the audits of these tax returns, the final determination of our obligations may exceed the amounts provided for by us in the accompanying consolidated financial statements.

Stock Option Review Risk Factors

The Audit Committee’s conclusion that certain historical stock option grants were not accounted for correctly has had, and could continue to have, an adverse effect on our financial results.

The Audit Committee has concluded that, primarily from fiscal 1998 through fiscal 2006, a large number of stock options were not accounted for correctly in our financial statements. As a result, we have restated our financial results for the years ended January 31, 1998 through the quarter ended April 31, 2006, and taken substantial compensation charges in each of those periods. We could continue to incur substantial charges in future periods in connection with the results of the review that are not compensation charges. Such charges could include, but are not limited to, payments to employees or taxing authorities arising from potential income tax liabilities pursuant to the U.S. Internal Revenue Code Section 409A.

 

32


Table of Contents

The Audit Committee’s review of our historical stock option grant practices, together with the preparation of the resulting financial restatements, has consumed considerable amounts of Board member and management time and caused us to incur substantial expenses, which have had and could continue to have an adverse effect on us.

The Audit Committee’s review of our historical stock option grants and the preparation of our restated consolidated financial statements have required us to expend significant Board member and management time, and to incur significant accounting, legal and other expenses. The review and preparation of our financial statements lasted over a year and required numerous meetings of the Audit Committee, the full Board of Directors and members of our senior management. The review has diverted the attention of our Board and management team from the operation of our business and proven to be a significant distraction. In addition, we have incurred substantial expenses in connection with the review, which have had and could continue to have a negative effect on our financial results. The period of time necessary to resolve these ongoing matters is uncertain, and these matters could require significant additional Board and management attention and resources.

The ongoing government inquiries relating to our historical stock option grant practices are time consuming and expensive and could result in injunctions, fines and penalties that may have a material adverse effect on our financial condition and results of operations.

The inquiries by the United States Securities and Exchange Commission (“SEC”) into our historical stock option grant practices are ongoing. We have fully cooperated with the SEC and intend to continue to do so. The period of time necessary to resolve these inquiries is uncertain, and we cannot predict the outcome of these inquiries or whether we will face additional government inquiries, investigations or other actions related to our historical stock option grant practices. These inquiries will likely require us to continue to expend significant management time and incur significant legal and other expenses, and could result in actions seeking, among other things, injunctions against the Company and the payment of significant fines and penalties by the Company, which may have a material adverse effect on our business and earnings.

As a result of the matters identified by the Audit Committee’s review of our historical stock option grant practices, we have failed to comply with SEC reporting requirements and Nasdaq listing requirements and may continue to face compliance issues with both. The continued failure by us to remain in compliance with SEC reporting requirements and Nasdaq listing requirements would likely have a material adverse effect on the Company and our stockholders.

Due to the Audit Committee’s review of our historical stock option grant practices and resulting restatements, we could not file our periodic reports with the SEC on a timely basis and faced the possibility of delisting from Nasdaq. With the filing of our Annual Report on Form 10-K for the year ended January 31, 2007 and Quarterly Reports on Form 10-Q for the quarters ended July 30, 2006, October 31, 2006, April 30, 2007 and July 31, 2007, we believe we have returned to full compliance with SEC reporting requirements and Nasdaq listing requirements and, therefore, that the Nasdaq delisting matter is now closed. However, if the SEC has comments on these reports (or other reports that we previously filed) that require us to file amended reports, or if Nasdaq does not concur that we are in compliance with applicable listing requirements, we may be unable to maintain the listing of our stock on Nasdaq. If this happens, the price of our stock and the ability of our stockholders to trade in our stock could be harmed. In addition, we would be subject to a number of restrictions regarding the registration of our stock under federal securities laws, and we would not be able to issue stock options or other equity awards to our employees or allow them to exercise their outstanding options, which could harm our business.

In addition, if we are not in compliance with our SEC reporting requirements in the future, it could have a negative impact on our reputation, including our relationships with our investors and our customers, our ability to acquire new customers, including new contracts with U.S. federal and other government entities, and, ultimately, our ability to generate revenue. Such lack of current information regarding us could also lead to our inability to access the capital markets for debt or loan financings because investors and lenders would not have information in order to evaluate us.

 

33


Table of Contents

We have been named as a party to a number of shareholder derivative lawsuits relating to our historical stock option grant practices, and we may be named in additional lawsuits in the future. This litigation could become time consuming and expensive and could have a material adverse effect on our business.

In connection with our historical stock option grant practices and resulting restatements, a number of derivative actions were filed against certain of our current and former directors and officers purporting to assert claims on the Company’s behalf. There may be additional lawsuits of this nature filed in the future. We cannot predict the outcome of these lawsuits, nor can we predict the amount of time and expense that will be required to resolve these lawsuits. If these lawsuits become time consuming and expensive, or if there are unfavorable outcomes in any of these cases, there could be a material adverse effect on our business, financial condition and results of operations.

Our insurance coverage will not cover our total liabilities and expenses in these lawsuits, in part because we have a significant deductible on certain aspects of the coverage. In addition, subject to certain limitations, we are obligated to indemnify our current and former directors, officers and employees in connection with the review of our historical stock option grant practices and the related litigation and government inquiries. We currently hold insurance policies for the benefit of our directors and officers, although our insurance coverage may not be sufficient in some or all of these matters. Furthermore, the insurers may seek to deny or limit coverage in some or all of these matters, in which case we may have to self-fund all or a substantial portion of our indemnification obligations.

We are subject to the risks of additional lawsuits in connection with our historical stock option grant practices, the resulting restatements, and the remedial measures we have taken.

In addition to the possibilities that there may be additional governmental actions and shareholder lawsuits against us, we may be sued or taken to arbitration by former officers and employees in connection with their stock options, employment terminations and other matters. These lawsuits may be time consuming and expensive, and cause further distraction from the operation of our business. The adverse resolution of any specific lawsuit could have a material adverse effect on our business, financial condition and results of operations.

If we fail to maintain effective internal controls or remediate any future material weaknesses in our internal control over financial reporting, we may be unable to accurately report our financial results or prevent fraud which could have an adverse effect on our business and operating results and our stock price.

The SEC, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public companies to include a report of management on internal control over financial reporting in their annual reports on Form 10-K that contain an assessment by management of the effectiveness of the Company’s internal control over financial reporting. Effective internal control over financial reporting is essential for us to produce reliable financial reports and prevent fraud. As a result of the Audit Committee’s review into our historical stock option grant practices and related matters, we identified past material weaknesses in our internal controls and procedures (see Item 9A—Controls and Procedures). A material weakness is a control deficiency, or combination of them, that results in more than a remote likelihood that a material misstatement in our financial statements will not be prevented or detected. A failure to implement and maintain effective internal control over financial reporting could harm our operating results, result in a material misstatement of our financial statements, cause us to fail to meet our financial reporting obligations or prevent us from providing reliable and accurate financial reports or avoiding or detecting fraud.

Failure to comply with applicable corporate governance requirements may cause us to delay filing our periodic reports with the SEC, affect our Nasdaq listing, and adversely affect our stock price.

Federal securities laws, rules and regulations, as well as Nasdaq rules and regulations, require companies to maintain extensive corporate governance measures, impose comprehensive reporting and disclosure

 

34


Table of Contents

requirements, set strict independence and financial expertise standards for audit and other committee members and impose civil and criminal penalties for companies and their chief executive officers, chief financial officers and directors for securities law violations. These laws, rules and regulations have increased and will continue to increase the scope, complexity and cost of our corporate governance, reporting and disclosure practices, which could harm our results of operations and divert management’s attention from business operations.

It may become more difficult and costly to obtain director and officer insurance coverage due to the results of our stock option review.

We expect that the issues arising from our review of stock option grant policies will make it more difficult to obtain director and officer insurance coverage in the future. If we are able to obtain this coverage, it could be significantly more costly than in the past, which would have an adverse effect on our financial results and cash flow. As a result of this and related factors, our directors and officers could face increased risks of personal liability in connection with the performance of their duties. As a result, we may have difficultly attracting and retaining qualified directors and officers, which could adversely affect our business.

Risks related to the Recent Acquisition Speculation and Investor Actions

Despite recent acquisition speculation and investor actions, a merger, acquisition or other transaction involving us may not occur or may occur at a price per share of our common stock that is below the current trading price, which could harm our stock price.

We face uncertainty concerning our future given certain investors' calls to auction us, the recent unsolicited cash public offer for us by Oracle at $17.00 per share of our common stock (which offer expired on October 28, 2007), and our board of directors’ stated willingness to negotiate the sale of us at $21.00 per share. As a result of these developments, our stock price has increased substantially in anticipation of a transaction, particularly after the public announcement of Oracle’s offer. There can be no assurance whether a transaction will occur or at what price. If a transaction does not occur, or the market perceives a transaction as unlikely to happen, our stock price may decline.

General customer uncertainty related to acquisition speculation and investor actions could harm our business.

Due to the uncertainty concerning an acquisition of us and the identity of the possible acquiror or its intentions, many of our current and potential customers may decide not to purchase from us or may defer purchasing decisions indefinitely. If our customers delay or defer purchasing decisions, particularly with respect to the million and multimillion dollar license transactions that we rely on, our revenues could materially decline or any anticipated increases in revenue could be lower than expected.

Acquisition speculation and investor actions could cause us to lose key personnel, prevent us from hiring additional key personnel and distract our management, which could harm our business.

Due to the recent acquisition speculation and investor actions, our current and prospective employees could experience uncertainty about their future roles within BEA as an independent entity or as an acquired business. This uncertainty may harm our ability to attract and retain key management, sales, marketing and technical personnel and may lead to increased employee attrition.

This acquisition speculation and investor activity also has diverted the attention of our management team from the operation of our business. Any failure to attract and retain key personnel and the distraction of our management could harm our business.

 

35


Table of Contents

We have been named in various stockholder and purported stockholder class action lawsuits for various matters related to the recent acquisition offer and takeover speculation, and we may be named in additional lawsuits in the future. This litigation could become time consuming and expensive, could prevent or delay any transaction and could harm our business.

We and members of our board of directors have been named in six purported stockholder class action complaints, two in the Delaware Chancery court, three in California in the Santa Clara County Superior Court (one of which purports also to be a derivative lawsuit) and one in the federal court for the Northern District of California (which was an amended complaint to the stock option review derivative action). Generally, these actions allege breach of fiduciary duties by our directors by failing to give proper consideration to the October 12, 2007 publicly announced and unsolicited bid by Oracle for us at $17.00 per share of our common stock (which offer expired on October 28, 2007), and seek damages and equitable relief. In addition, a group of affiliated stockholders has brought an action against us and members of our board of directors in Delaware Chancery Court seeking to compel us to hold our annual meeting on or before November 30, 2007, and to enjoin us from taking certain actions pending the annual meeting. For a complete description of these actions, see Item 3. “Legal Proceedings.” We have obligations under certain circumstances to indemnify each of the defendant directors against judgments, fines, settlements and expenses related to claims against such directors and otherwise to the fullest extent permitted under Delaware law and our bylaws and certificate of incorporation. We cannot predict the outcome of these lawsuits, nor can we predict the amount of time and expense that will be required to resolve these lawsuits. If these lawsuits or any future lawsuits become time consuming and expensive, or if there are unfavorable outcomes in any of these cases, any acquisition transaction could be prevented or delayed or our business could be harmed.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS.

None.

 

ITEM 2. PROPERTIES.

Our corporate headquarters, totaling approximately 236,000 square feet, are located in San Jose, California under leases expiring in July 2008. We also lease office space in various locations throughout the United States for sales, support, marketing and product development personnel, and our foreign subsidiaries lease space for their respective operations. We own substantially all of the equipment used in our facilities.

In October 2003, we purchased an approximately 40-acre parcel of land located on North First Street, San Jose, California adjacent to our corporate headquarters (the “San Jose Land”), on which the Company planned to develop and build a new corporate headquarters, adjacent to our San Jose, California leased offices. In the first quarter of fiscal 2008, after evaluation of our facilities options and strategy with respect to our corporate headquarters in San Jose, California, we sold the San Jose Land. Thereafter, we purchased a 17-story building with parking facilities in downtown San Jose (the “San Jose Building”), which the Company intends to make its new corporate headquarters. Upon completion of leasehold improvements to make the building ready to occupy, we plan to move into that San Jose Building in the first half of calendar 2008. We recorded the sale of the San Jose Land and the purchase of the San Jose Building in the first quarter of fiscal 2008, and we recorded the new building as a capital asset at cost.

As of January 31, 2007, we determined that there was a more likely than not chance that the San Jose Land would be disposed of within the next 12 months. We completed an impairment review in accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, and we concluded that a $201.6 million write-down of the San Jose Land was required, reducing the value of that land to a new carrying value of $105.0 million. The San Jose Land was subsequently sold in the first quarter of fiscal 2008 for $106.0 million, net of transaction costs.

 

36


Table of Contents
ITEM 3. LEGAL PROCEEDINGS.

The Company and its subsidiary Plumtree Software, Inc. (“Plumtree”) are involved in a patent infringement lawsuit against Datamize, LLC (“Datamize”) in the U.S. District Court for the Northern District of California. In July 2004, Plumtree sued Datamize for declaratory judgment that certain U.S. patents are invalid and not infringed. In January 2007, Datamize answered Plumtree’s complaint and counterclaimed for infringement. In July 2007 the parties were realigned so that Datamize is the plaintiff, and BEA was added to the case as a defendant. The Court issued its claim construction order on August 7, 2007. Trial is set for August 18, 2008. Plumtree and the Company intend to vigorously pursue their claim for declaratory relief and vigorously defend against Datamize’s allegations of infringement. It is not known when or on what basis this action will be resolved.

On August 23, 2005, a class action lawsuit titled Globis Partners, L.P. v. Plumtree Software, Inc. et al. was filed in the Court of Chancery in the State of Delaware in and for New Castle County (the “Globis Action”). The complaint names Plumtree, all members of Plumtree’s board of directors and the Company as defendants. The suit alleges, among other claims, that the consideration to be paid in the proposed acquisition of Plumtree by the Company is unfair and inadequate. The complaint seeks an injunction barring consummation of the merger and, in the event that the merger is consummated, a rescission of the merger and an unspecified amount of damages. The Company is defending the case vigorously. There can be no assurance, however, that we will be successful in our defense of this action. It is not known when or on what basis the action will be resolved.

In addition, on August 24, 2005, a class action lawsuit titled Keitel v. Plumtree Software, Inc., et al. was filed in the Superior Court of the State of California for the County of San Francisco (the “Keitel Action”). The complaint names Plumtree and all member of Plumtree’s board of directors as defendants alleging similar complaints and seeking similar damages as the class action brought by Globis Partners, L.P. The Keitel Action has been stayed pending the outcome of the Globis Action. The Company is defending the case vigorously. There can be no assurance, however, that we will be successful in our defense of this action. It is not known when or on what basis this action will be resolved.

In the Keitel Action, plaintiffs sought an injunction against completion of the merger. That motion was denied and the case has now been stayed. In the Globis Action, plaintiff filed an amended complaint on October 22, 2005, which the Company moved to dismiss on October 6, 2006. Plumtree and the individual defendants moved to dismiss the amended complaint on the same date. On December 8, 2006, plaintiff moved for leave to file a second amended complaint. On January 4, 2007, parties stipulated to permit plaintiff to file the second amended complaint. It was filed on January 16, 2007. Defendants moved to dismiss the second amended complaint on February 5, 2007. The briefing on the motions has been completed. Currently, the parties are waiting for the Court to set a date for the hearing. There can be no assurance that we will be able to achieve a favorable resolution. An unfavorable resolution of the pending litigation could result in the payment of substantial damages which could have a material adverse effect on our business, financial condition and results of operations. In addition, as a result of the merger, we have assumed all liabilities of Plumtree resulting from the litigation.

On July 20, 2006, the first of several derivative lawsuits was filed by a purported Company shareholder in the United States District Court for the Northern District of California. The cases were subsequently consolidated and plaintiffs’ current complaint names certain of the Company’s present and former officers and directors as defendants and names the Company as a nominal defendant. The complaint alleges that the individual defendants violated the federal securities laws and breached their duties to the Company in connection with our historical stock option grant activities. In addition, the current complaint includes a claim purportedly on behalf of a class of BEA shareholders arising out of Oracle’s unsolicited acquisition proposal, claiming that members of our Board of Directors breached their fiduciary duties in response to the proposal. It is not known when or on what basis the action will be resolved.

 

37


Table of Contents

In addition, on August 25, 2006, another shareholder derivative action was filed in the Superior Court for the County of Santa Clara. The court granted a motion to stay that action in deference to the actions filed previously in federal court. It is not known when or on what basis the action will be resolved.

On July 20, 2006, the first of several derivative lawsuits was filed by a purported Company shareholder in the United States District Court for the Northern District of California. The cases were subsequently consolidated and plaintiffs’ current complaint names certain of the Company’s present and former officers and directors as defendants and names the Company as a nominal defendant. The complaint alleges that the individual defendants violated the federal securities laws and breached their duties to the Company in connection with our historical stock option grant activities. On October 25, 2007, the complaint was amended to assert a purported class action claim alleging that the Company’s directors breached their fiduciary duties by failing to fully inform themselves of the Company’s true value prior to rejecting Oracle’s unsolicited proposal to acquire the Company for $17.00 per share. Plaintiffs seek an order requiring the director defendants to implement a procedure or process to determine the Company’s true value and obtain the highest possible price for shareholders. The Company is defending the case vigorously. There can be no assurance, however, that we will be successful in our defense of this action. It is not known when or on what basis this action will be resolved.

On October 12, 2007, a class action lawsuit titled Freedman v. BEA Systems, Inc. et al. was filed in the Court of Chancery in the State of Delaware in and for New Castle County (the “Freedman Action”). The complaint names the Company and its directors as defendants, asserting that the directors breached their fiduciary duties by failing to give proper consideration to Oracle’s unsolicited proposal to acquire us for $17.00 per share. The complaint seeks injunctive relief, including the implementation of a process or procedure to obtain the highest possible price for the Company’s shareholders through negotiations with Oracle or other means. The Company is defending the case vigorously. There can be no assurance, however, that we will be successful in our defense of this action. It is not known when or on what basis this action will be resolved.

On October 12, 2007, a class action lawsuit titled Blaz v. BEA Systems, Inc. et al. was filed in the Court of Chancery in the State of Delaware in and for New Castle County (the “Blaz Action”). The complaint names the Company and its directors as defendants, asserting that the directors breached their fiduciary duties by failing to give proper consideration to Oracle’s unsolicited proposal to acquire the Company for $17.00 per share. The complaint seeks injunctive relief, including the implementation of a process or procedure to obtain the highest possible price for the Company’s shareholders through negotiations with Oracle or other means. The Company is defending the case vigorously. There can be no assurance, however, that we will be successful in our defense of this action. It is not known when or on what basis this action will be resolved.

On October 12, 2007, a class action lawsuit titled Gross v. BEA Systems, Inc. et al. was filed in the Superior Court of the State of California for the County of Santa Clara (the “Gross Action”). The complaint names the Company, eight of its directors, and certain unnamed “John Doe” parties as defendants, alleging that the directors breached their fiduciary duties by failing to give proper consideration to Oracle’s unsolicited proposal to acquire the Company for $17.00 per share. The complaint seeks injunctive relief, including an order requiring the defendants to cooperate with any party expressing a bona fide interest in making an offer that maximizes the value of the Company’s shares and the formation of a stockholders’ committee to ensure the fairness of any transaction involving the Company’s shares. The complaint also seeks compensatory damages in an unspecified amount. The Company is defending the case vigorously. There can be no assurance, however, that we will be successful in our defense of this action. It is not known when or on what basis this action will be resolved.

On October 12, 2007, a class action lawsuit titled Ellman v. Chuang et al. was filed in the Superior Court of the State of California for the County of Santa Clara (the “Ellman Action”). The complaint names nine of the Company’s directors as defendants and the Company as a nominal defendant, alleging that the directors breached their fiduciary duties by failing to adequately consider Oracle’s unsolicited proposal to acquire the Company for $17.00 per share. In addition, the complaint asserts a derivative cause of action against the director defendants, ostensibly on behalf of and for the benefit of the Company, again alleging that the director defendants breached

 

38


Table of Contents

their fiduciary duties by failing to adequately consider Oracle’s proposal. The complaint seeks injunctive relief, including an order requiring the Company’s directors to respond reasonably to offers that are in the best interests of shareholders, a prohibition on entry into any contractual provisions designed to impede the maximization of shareholder value, and an order restraining the defendants from adopting or using any defensive measures against a potential acquiror. The Company is defending the case vigorously. There can be no assurance, however, that we will be successful in our defense of this action. It is not known when or on what basis this action will be resolved.

A shareholder class action lawsuit titled Zwick v. BEA Systems, Inc. et al. may be filed in the Superior Court of the State of California for the County of Santa Clara (the “Zwick Action”). The complaint names the Company, eight of its current directors, and certain unnamed “John Doe” parties as defendants. The complaint alleges that the director defendants breached their fiduciary duties by failing to give proper consideration to Oracle’s unsolicited proposal to acquire the Company for $17.00 per share. The complaint seeks injunctive relief, including an order requiring the defendants to cooperate with any party expressing a bona fide interest in making an offer that maximizes the value of the Company’s shares and the formation of a stockholders’ committee to ensure the fairness of any transaction involving the Company’s shares. The complaint also seeks compensatory damages in an unspecified amount. Plaintiffs indicated their intention to file this suit on October 26, 2007, but as of October 27, 2007, the Company has no confirmation that the suit has in fact been filed. If the suit is filed, the Company will defend the case vigorously. There can be no assurance, however, that we will be successful in our defense of this potential action. It is not known when or on what basis this action will be resolved.

On October 26, 2007, a lawsuit titled High River Ltd. P’Ship et al. v. BEA Systems, Inc. et al. was filed in the Court of Chancery in the State of Delaware in and for New Castle County (the “High River Action”). The action was brought by High River Ltd. Partnership and certain affiliated parties who purport to collectively beneficially own almost 14 percent of the Company’s stock. The complaint seeks, pursuant to Del. C. § 211, to compel the Company to hold an annual meeting on or before November 30, 2007, and to enjoin the Company from taking certain actions pending the next annual meeting. The Company is defending the case vigorously. There can be no assurance, however, that we will be successful in our defense of this action. It is not known when or on what basis this action will be resolved.

The Company is subject to legal proceedings and other claims that arise in the ordinary course of business, such as those arising from domestic and foreign tax authorities, intellectual property matters and employee related matters, in the ordinary course of its business. While management currently believes the amount of ultimate liability, if any, with respect to these actions will not materially affect the Company’s financial position, results of operations or liquidity, the ultimate outcome could be material to the Company. It is not known when or on what basis this action will be resolved.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 2007.

 

39


Table of Contents

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Since our initial public offering on April 11, 1997, our common stock has traded on the NASDAQ National Market under the symbol “BEAS”. According to our transfer agent, we had approximately 731 stockholders of record as of October 31, 2007.

The following table sets forth the high and low sales prices reported on the NASDAQ National Market for our common stock for the periods indicated:

 

     Low    High

Fiscal year ended January 31, 2008:

     

Fourth Quarter (through November 12, 2007)

   $ 16.55    $ 17.32

Third Quarter

     11.02      18.94

Second Quarter

     10.50      14.32

First Quarter

     10.80      13.34

Fiscal year ended January 31, 2007:

     

Fourth Quarter

   $ 12.00    $ 16.28

Third Quarter

     10.81      16.77

Second Quarter

     11.05      13.77

First Quarter

     10.20      14.29

Fiscal year ended January 31, 2006:

     

Fourth Quarter

   $ 8.75    $ 10.85

Third Quarter

     8.09      9.67

Second Quarter

     6.86      9.41

First Quarter

     6.78      8.94

We have never declared or paid any cash dividends on our common stock. We currently intend to invest cash generated from operations, if any, to support the development of our business and do not anticipate paying cash dividends for the foreseeable future. Payment of future dividends, if any, will be as determined by of our Board of Directors.

Issuer Purchases of Equity Securities

Stock Repurchases:

In September 2001, the Board of Directors approved a share repurchase program for the Company to repurchase up to $100.0 million of its common stock (the “Share Repurchase Program”). In March 2003, the Board of Directors approved a repurchase of up to an additional $100.0 million of our common stock under the Share Repurchase Program. In May 2004 and March 2005, the Board of Directors approved repurchases of up to an additional $200.0 million (an aggregate of $600.0 million) of our common stock under the Share Repurchase Program. At January 31, 2007, $121.8 million of the aggregate $600.0 million remained available for future purchases. In May 2007 the Board of Directors approved repurchases of up to an additional $500.0 million (an aggregate of $1.1 billion) of our common stock under the Share Repurchase Program. The Share Repurchase Program does not have an expiration date. No purchases were made in fiscal 2007 in part due to the stock option restatement and no purchases were made through the date of this filing due to the stock option review.

 

40


Table of Contents

PERFORMANCE GRAPH

LOGO

 

41


Table of Contents
ITEM 6. SELECTED FINANCIAL DATA.

The consolidated balance sheet as of January 31, 2006 and the consolidated statements of income for the fiscal years ended January 31, 2006 and 2005 have been restated as set forth in this 2007 Form 10-K. The data for the consolidated balance sheets as of January 2005, 2004 and 2003 and the consolidated statements of income for the fiscal years ended January 31, 2004 and 2003 have been restated to reflect the impact of the stock-based compensation adjustments, but such restated data has not been audited and is derived from the books and records of the company. The information set forth below is not necessarily indicative of results of future operations, and should be read in conjunction with the Consolidated Financial Statements and Notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes thereto included in Item 8 of this Form 10-K to fully understand factors that may affect the comparability of the information presented below. The information presented in the following tables has been adjusted to reflect the restatement of the company’s financial results, which is more fully described in the “Explanatory Note” immediately preceding Part I Item 1, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations’ and in Note 2, “Restatement of Consolidated Financial Statements” in Notes to Consolidated Financial statements of this Form 10-K.

The Company has not amended its previously-filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the periods affected by this restatement. The financial information that has been previously filed or otherwise reported for these periods is superseded by the information in this 2007 Form 10-K dated January 31, 2007, and the financial statements and related financial information contained in such previously-filed reports should no longer be relied upon. Our restated interim financial statements for the quarterly and year-to-date period ended July 31, 2005, October 31, 2005 and April 30, 2006 will be included in our quarterly reports on Form 10-Q for the periods ended July 31, 2006, October 31, 2006 and April 30, 2007, respectively.

 

     For the fiscal year ended January 31,  
     2007(a)    

2006

As restated(1)(b)

   

2005

As restated(1)(c)

   

2004

As restated(1)

   

2003

As restated(1)

 
     (in thousands, except per share data)  

Total revenues

   $ 1,402,349     $ 1,199,845     $ 1,080,094     $ 1,012,492     $ 934,058  

Cost of revenues

     333,326       257,212       224,873       239,166       229,013  

Gross profit

     1,069,023       942,633       855,221       773,326       705,045  

Operating expenses

     1,102,654       734,035       649,690       641,330       637,935  

Operating income (loss)

     (33,631 )     208,598       205,531       131,996       67,110  

Other income and expense

     44,317       9,589       (7,646 )     (5,163 )     (13,910 )

Income before tax

     10,686       218,187       197,885       126,833       53,200  

Income tax provision

     (6,186 )     (75,017 )     (52,188 )     (18,797 )     (12,285 )

Net income

     4,500       143,170       145,697       108,036       40,915  

Net income per share:

          

Basic

   $ 0.01     $ 0.37     $ 0.36     $ 0.27     $ 0.10  

Diluted

   $ 0.01     $ 0.36     $ 0.35     $ 0.26     $ 0.10  

(a) Includes the following significant pre-tax items: land impairment charge of $201.6 million, additional facilities consolidation expense $0.5 million, acquisition related in-process research and development of $4.4 million. Also includes $11.1 million of net gains on minority interest in equity investments and $0.8 million of net gains on retirement of the 2006 convertible subordinated notes in Other income and expense.

 

(b) Includes the following significant pre-tax items: additional facilities consolidation expense $0.8 million, acquisition related in-process research & development (“IPR&D”) of $4.6 million. Also includes $0.7 million of net gains on retirement of the 2006 convertible subordinated notes in Other income and expense.

 

(c) Includes the following significant pre-tax items: facilities consolidation expense of $8.2 million, acquired intangible asset impairment charge of $1.1 million.

 

(1) See the “Explanatory Note” immediately preceding Part I, Item 1, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations’ and Note 2, “Restatement of Consolidated Financial Statements,” in Notes to Consolidated Financial Statements of this Form 10-K.

 

42


Table of Contents

The following table presents the effects of the restatement adjustments upon the Company’s previously reported consolidated statements of income data.

 

    For the fiscal year ended January 31,  
    2006     2005  
    As Reported     Adjustments     As restated     As Reported     Adjustments     As Restated  
    (in thousands, except per share data)  

Total revenues

  $ 1,199,845     $ —       $ 1,199,845     $ 1,080,094     $ —       $ 1,080,094  

Cost of revenues

    258,442       (1,230 )     257,212       232,667       (7,794 )     224,873  

Gross Margin

    941,403       1,230       942,633       847,427       7,794       855,221  

Total operating expenses

    735,567       (1,532 )     734,035       652,558       (2,868 )     649,690  

Operating income (loss)

    205,836       2,762       208,598       194,869       10,662       205,531  

Other income and expense

    9,589       —         9,589       (7,646 )     —         (7,646 )

Income before taxes

    215,425       2,762       218,187       187,223       10,662       197,885  

Income taxes (provision) benefit

    (72,682 )     (2,335 )     (75,017 )     (56,167 )     3,979       (52,188 )

Net income

    142,743       427       143,170       131,056       14,641       145,697  

Net income per share:

           

Basic

  $ 0.37     $ —       $ 0.37     $ 0.32     $ 0.04     $ 0.36  

Diluted

  $ 0.36     $ —       $ 0.36     $ 0.32     $ 0.03     $ 0.35  
    For the fiscal year ended January 31,  
    2004     2003  
    As Reported     Adjustments     As restated     As Reported     Adjustments     As Restated  
    (in thousands, except per share data)  

Total revenues

  $ 1,012,492     $ —       $ 1,012,492     $ 934,058     $ —       $ 934,058  

Cost of revenues

    236,934       2,232       239,166       222,290       6,723       229,013  

Gross Margin

    775,558       (2,232 )     773,326       711,768       (6,723 )     705,045  

Total operating expenses

    600,861       40,469       641,330       578,035       59,900       637,935  

Operating income

    174,697       (42,701 )     131,996       133,733       (66,623 )     67,110  

Other income and expense

    (5,163 )     —         (5,163 )     (13,910 )     —         (13,910 )

Income before taxes

    169,534       (42,701 )     126,833       119,823       (66,623 )     53,200  

Income taxes (provision) benefit

    (50,860 )     32,063       (18,797 )     (35,947 )     23,662       (12,285 )

Net income

    118,674       (10,638 )     108,036       83,876       (42,961 )     40,915  

Net income per share:

           

Basic

  $ 0.29     $ (0.02 )   $ 0.27     $ 0.21     $ (0.11 )   $ 0.10  

Diluted

  $ 0.28     $ (0.02 )   $ 0.26     $ 0.20     $ (0.10 )   $ 0.10  

 

43


Table of Contents

Consolidated Balance Sheet Data (in thousands):

 

    As of January 31,
    2007  

2006

As restated(1)

 

2005

As restated(1)

 

2004

As restated(1)

 

2003

As restated(1)

    (in thousands, except per share data)

Cash and cash equivalents

  $ 867,294   $ 1,017,772   $ 777,754   $ 683,729   $ 578,717

Short-term and long-term investments

    407,469     435,185     830,063     783,288     688,753

Goodwill

    233,998     138,235     52,791     46,481     46,277

Total assets

    2,398,842     2,468,243     2,338,335     2,205,567     1,799,193

Deferred revenue

    449,282     379,123     312,310     273,879     233,758

Long-term obligations

    228,790     227,388     780,194     745,672     554,215

Total stockholders’ equity

    1,364,610     1,096,199     1,002,150     909,304     751,827

(1) See the “Explanatory Note” immediately preceding Part I, Item 1, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations’ and Note 2, “Restatement of Consolidated Financial Statements,” in Notes to Consolidated Financial Statements of this Form 10-K.

 

    As of January 31,
    2006   2005
    As Reported   Adjustments     As restated   As Reported   Adjustments     As Restated
    (in thousands, except per share data)

Cash and cash equivalents

  $ 1,017,772   $ —       $ 1,017,772   $ 777,754   $ —       $ 777,754

Short-term and long-term investments

    435,185     —         435,185     830,063     —         830,063

Goodwill

    145,523     (7,288 )     138,235     62,410     (9,619 )     52,791

Total assets

    2,475,531     (7,288 )     2,468,243     2,348,394     (10,059 )     2,338,335

Deferred revenue

    379,123     —         379,123     312,310     —         312,310

Long-term obligations

    227,388     —         227,388     780,194     —         780,194

Total stockholders’ equity

    1,110,237     (14,038 )     1,096,199     1,033,167     (31,017 )     1,002,150
    As of January 31,
    2004   2003
    As Reported   Adjustments     As restated   As Reported   Adjustments     As Restated
    (in thousands, except per share data)

Cash and cash equivalents

  $ 683,729   $ —       $ 683,729   $ 578,717   $ —       $ 578,717

Short-term and long-term investments

    783,288     —         783,288     688,753     —         688,753

Goodwill

    56,100     (9,619 )     46,481     53,565     (7,288 )     46,277

Total assets

    2,220,189     (14,622 )     2,205,567     1,809,959     (10,766 )     1,799,193

Deferred revenue

    273,879     —         273,879     233,758     —         233,758

Long-term obligations

    745,672     —         745,672     554,215     —         554,215

Total stockholders’ equity

    970,138     (60,834 )     909,304     805,949     (54,122 )     751,827

 

44


Table of Contents
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The information below has been adjusted to reflect the restatement of our financial results which is more fully described in the “Explanatory Note” immediately preceding Part I, Item 1, and in Note 2, “Restatement of Consolidated financial Statements,” in Notes to Consolidated Financial Statements of this Form 10-K.

Executive Summary of Financial Results

Fiscal 2007

During fiscal 2007, revenues increased 17 percent from 2006 due to an increase of both license and services revenues. This revenue growth was due in large part to the AquaLogic product family which is comprised of products that were organically developed (e.g., AquaLogic Service Bus was introduced in August 2005) and products acquired through the purchase of Plumtree Software Inc. (“Plumtree”) in October 2005 and Fuego Inc. (“Fuego”) in February 2006. Fiscal 2007 revenues increased 17 percent compared to fiscal 2006 due to a 12 percent increase for license revenues and a 20 percent increase for services revenue (customer support and maintenance, consulting and education). The increase in services revenue was primarily due to an increase in the customer support and maintenance revenues. Geographically, the Americas (U.S., Canada, Mexico and Latin America), Europe, Middle East and Africa (“EMEA”) and Asia/Pacific (“APAC”), all reported revenue growth year over year. Additionally in fiscal 2007, our international revenues benefited approximately 1 percent due to exchange rate fluctuations year over year.

In fiscal 2007, most expenses increased in absolute dollars, as well as a percentage of revenues. In fiscal 2007, stock-based compensation expense increased significantly due to FAS 123R expense of $54.4 million and $2.8 million of expenses associated with stock option modifications. These stock-based compensation expenses impacted all functional lines of the business. The Company also integrated the Plumtree and Fuego operations into BEA, which also impacted all functional lines of the business. In addition to the stock-based compensation expense and the integration of multiple acquisitions, sales and marketing, research and development (R&D), and general and administrative (G&A) expenses increased year over year. The increase in sales and marketing was primarily attributable to compensation and sales related expenses. The increase in R&D was due in part to the integration of acquisitions completed in the second half of fiscal 2006 and their comparison to a full year of expenses in fiscal 2007. The increase was driven by a decline in third party funding associated with product development agreements and continued investment in research and development, specifically related to the international telecommunications technology centers. G&A increased primarily due to stock option review expenses, certain legal expenses and compensation related expenses. Our international expenses, were negatively impacted by approximately 1 percent due to exchange rate fluctuations year on year.

During the fourth quarter of fiscal 2007, we evaluated our facilities options and strategy with respect to our leased corporate headquarters in San Jose, California, whose leases expire in July 2008. Based on the results of this evaluation, we concluded that it was unlikely that we would occupy the land, and therefore we evaluated it for impairment.

As of January 31, 2007, we determined that there was a more likely than not chance that the San Jose Land would be disposed of within the next 12 months. We completed an impairment review in accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, and we concluded that a $201.6 million write-down of the San Jose Land was required, reducing the value of the San Jose land to a new carrying value of $105.0 million. The San Jose Land was subsequently sold in the first quarter of fiscal 2008 for $106.0 million, net of transaction costs.

In fiscal 2006 we acquired five software companies, one of which was Plumtree, a public company that had established license and services revenues. We purchased Plumtree in the third quarter of fiscal 2006 for approximately $211.1 million. We reflected 10 days of total revenue and expenses related to Plumtree in the third

 

45


Table of Contents

quarter of fiscal 2006 and a full quarter of revenue and expenses in the fourth quarter of fiscal 2006. Consequently, comparisons between fiscal 2007 and fiscal 2006 are impacted by this acquisition. In February 2006, we purchased Fuego Inc. for approximately $88.4 million.

In August 2006, the Company acquired Flashline, Inc. for approximately $43.6 million. Neither Fuego or Flashline had significant pre-existing revenue streams.

In fiscal 2007, the effective tax rate was 57.9 percent compared to 34.4 percent in fiscal 2006. The increase in the effective tax rate was primarily due to the increase in non-deductible stock based compensation and the increase in the valuation allowance which was partially offset by higher benefits of low taxed foreign earnings and research credits.

In fiscal 2006, the effective tax rate was 34.4 percent compared to 26.4 percent in fiscal 2005. The increase in the effective tax rate was primarily due to the limitation of certain deductions in fiscal 2006 related to officer’s compensation, the deduction of which is subject to limitations under Internal Revenue Code (“IRC”) 162(m). These limitations arose as a byproduct of the new measurement dates assigned to certain options, which were exercised in fiscal 2006, based on the independent stock option review.

Fiscal 2006

During fiscal 2006, revenues increased 11 percent from fiscal 2005 due to an increase in both license and services. Management believes that this revenue growth was driven by our three key go-to-market initiatives and increased demand for our products. The go-to-market initiatives were: (1) expanding our enterprise account program, (2) expanding our solutions frameworks program and (3) expanding our Americas value-added reseller (“VAR”) channel. The increased demand for our products was driven by improved demand for our core WebLogic product family and the introduction of our new product family, AquaLogic. A significant portion of the AquaLogic growth was contributed by the acquisition of Plumtree Software, Inc. (“Plumtree”), which was acquired in October 2005, and the remainder was due to new product introductions. Fiscal 2006 revenues increased 11 percent compared to fiscal 2005 due to a 6 percent increase for license revenues and a 15 percent increase for services revenue (customer support, consulting and education). The increase in services revenue was primarily due to an increase in the customer support and maintenance revenues. Geographically, the Americas (U.S., Canada, Mexico and Latin America), Europe, Middle East and Africa (“EMEA”) and Asia/Pacific (“APAC”), all reported revenue growth year over year.

Though most expenses increased in absolute dollars in fiscal 2006 and 2005, they remained relatively consistent year over year as a percentage of revenues, with the exception of research and development (“R&D”) and general and administrative expenses (“G&A”). The increase in R&D was due to continued investment in a new product cycle manifested primarily through compensation related expenses from acquisitions as well as organic growth. G&A increased primarily due to certain legal expenses, tax services and compensation related expenses. Additionally in 2006, our international revenues and profitability, which both grew year over year, did not benefit from exchange rates, whereas in fiscal 2005, our revenues and profitability significantly benefited from exchanges rates.

On October 20, 2005, BEA systems acquired all the outstanding shares of Plumtree Software, Inc. (“Plumtree”), a publicly held software company headquartered in San Francisco, California. Plumtree provides enterprise portal solutions to connect disparate work groups, IT systems and business processes. Under the terms of the merger agreement dated August 22, 2005, Plumtree stockholders received $5.50 per share in cash for each outstanding share of Plumtree stock. In addition, vested Plumtree stock option holders received cash equal to the difference between $5.50 per share and the exercise price of the vested employee stock options. Unvested employee stock options to purchase Plumtree common stock were converted into options to purchase shares of BEA common stock for employees continuing their employment with the combined Company. The final purchase price for Plumtree was $211.1 million.

 

46


Table of Contents

In addition to Plumtree, in fiscal 2006, we completed four acquisitions of small private companies purchased primarily for the value that their technology components are expected to add to our product families. All acquisitions were cash-based transactions.

Effective January 30, 2006, the Company accelerated the vesting of unvested and “out of the money” stock options previously awarded to employees and officers of the Company with option exercise prices greater than $10.72. Options held by non-employee directors were unaffected by the vesting acceleration. Options held by the Company’s CEO and other executive officers were eligible for accelerated vesting subject to a Resale Restriction Agreement imposing limitations on the sale of such accelerated options equivalent to the pre-acceleration vesting schedule.

Three executive officers participated in the acceleration and the related resale restriction and the remaining executive officers declined the acceleration. Certain international locations were excluded from the acceleration because it would have had a negative tax impact to the employees. The Company accelerated options with an exercise price of $10.72 or higher (stock price at the close of business on January 30, 2006) which comprises approximately 4 percent of total outstanding options. This acceleration was done in anticipation of implementing FAS123R and the Company expects to forego approximately $19.4 million of stock compensation expense in future operating results commencing in the first fiscal quarter of 2007 when FAS123R is implemented.

During fiscal 2006, the Company’s Chief Executive Officer and Board of Directors approved a domestic reinvestment plan as required by the American Jobs Creation Act (the “Jobs Act:”) to repatriate $169.6 million in foreign earnings in fiscal 2006. The Company repatriated $169.6 million under the Jobs Act in fiscal 2006 and recorded tax expense in fiscal 2006 of $10.4 million related to this repatriation dividend.

Seasonality

Our first fiscal quarter license revenues are typically lower than license revenues in the immediately preceding fourth fiscal quarter because our commission plans and other sales incentives are structured for annual performance and contain bonus provisions based on annual quotas that typically are triggered in the later quarters in a fiscal year. In addition, many of our customers begin a new fiscal year on January 1 and it is common for capital expenditures to be lower in an organization’s first quarter than in its fourth quarter. We anticipate that the negative impact of seasonality on our first fiscal quarter results will continue. Our cash flows and deferred revenue balances also tend to fluctuate seasonally based in-part by the seasonality of our license business.

Due to the seasonality of license revenue, a greater than proportional amount of our customer support contracts are renewed in the fourth quarter, which leads to a significant increase in deferred customer support revenue in the fourth quarter. The recognition of this deferred revenue occurs over the following four quarters and consequently deferred support revenue generally declines in the first three quarters of the next fiscal year. Due to the significant increase in deferred customer support revenue balance in the fourth quarter, there is a greater than proportional cash collection of the respective receivables that occurs in the fourth quarter and the first quarter of the following fiscal year. Consequently operating cash flow is seasonally strong in the fourth quarter and first quarter and weaker in the second and third quarters of a fiscal year.

Background of the Stock Option Review, Findings and Restatement of Consolidated Financial Statements

Independent Review Overview

On August 14, 2006, the Audit Committee of the Board of Directors of the Company recommended to the Board, and the Board agreed, that the Audit Committee retain independent counsel to assist with a thorough review of the Company’s historical stock option grant practices (“Independent Review”). The Audit Committee conducted the Independent Review with the assistance of independent legal counsel Simpson Thacher & Bartlett LLP (“Simpson Thacher”) and forensic accountants Navigant Consulting, Inc. (“Navigant”), collectively the (“Review Firms”). The Independent Review, which commenced in August 2006 and encompassed all of the

 

47


Table of Contents

Company’s stock option grants from January 1996 through June 2006 (“Review Period”), excluding stock options acquired as part of business combinations, consisted of a review of the Company’s historic stock option granting practices, including a review of whether we used appropriate measurement dates, and, therefore, correctly accounted for stock option grants made under our equity award programs.

Scope and Findings of the Independent Review

The Independent Review encompassed the period January 1996 through June 2006 and covered all stock options granted by the Company, excluding stock options assumed as part of business combinations. The Company determined that stock options assumed in acquisitions and included in the determination of the purchase price were measured at the fair value of the stock options on the date specified in EITF Issue No. 99-12, “Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination” and compensation cost was measured when the acquisition closed.

As part of the Independent Review, the Review Firms examined various and extensive data and documentation, including, but not limited to:

 

   

More than 4.5 million pages of hardcopy and electronic documents, including documents from approximately 30 custodians, as well as Company records from the Human Resources Department, Stock Administration Department, Finance Department, and Legal Department;

 

   

Actions by Unanimous Written Consent related to the Company’s stock options (“UWCs”) and other granting actions from approximately January 1996 through June 2006;

 

   

Board meeting minutes and related materials from approximately January 1996 through June 2006;

 

   

Audit Committee meeting minutes and related materials from approximately August 1997 through June 2006;

 

   

Compensation Committee meeting minutes and related materials from approximately March 1998 through June 2006;

 

   

Over 1,200 employee separation agreements from approximately April 1997 through June 2006;

 

   

The Company’s E*Trade Equity Edge™ Stock Administration database (“Equity Edge”), as of October 2006;

 

   

Reports generated from the Peoplesoft Enterprise Resource Planning application (“Peoplesoft ERP”);

 

   

The Company’s publicly filed 10-Ks, 10-Qs, Proxy Statements, Form 4s, Form 5s, as well as 8-Ks relating to the Company’s stock options, from approximately April 1997 to June 2006.

In addition, Simpson Thacher interviewed certain individuals that were part of the option granting process for the time period under review, including current and former Section 16 officers, Directors, rank-and-file employees and outside advisors. With one exception, Simpson Thacher was able to interview all of the individuals that they had sought to interview as part of the Independent Review. One former employee, a stock administration staff member who voluntarily left the Company before the commencement of the Independent Review, declined to be interviewed.

Statistical analyses were utilized to determine if grants had been made at or near monthly lows, or if specific grants had unusual positive returns that were preceded by unusual price decreases (“V flag”). The first analysis included 319 grant dates from April 11, 1997 through December 31, 2002. Of the 319 grant dates analyzed, 36 received a V flag. In addition, 28 grant dates were at monthly lows, including 11 of the 36 grant dates that received a V flag. The monthly lows and the V flags included grants to rank-and-file employees and Section 16 officers. Assuming the grant dates were selected randomly, the probability of 36 grant dates having a V flag is less than 1%, and the probability of 28 grant dates being at a monthly low is also less than 1%.

 

48


Table of Contents

The second analysis focused on a subset of the first analysis and included nine grant dates where a UWC was used to grant stock options to the Chief Executive Officer’s (“CEO”) and either the former or current CEO was the sole signatory on the UWC (the grant dates ranged from March 1998 to July 2002). Of the nine grant dates analyzed, 4 received a V flag. Three of those four grant dates as well as two additional grant dates (five in total) were at monthly lows. Assuming the grant dates were selected randomly, the probability of four grant dates having a V flag is less than 1%, and the probability of five grant dates being at a monthly low is less than 1%.

The third analysis focused on grant dates outside of the Company’s pre-determined grant date cycle subsequent to February 5, 2003. Seven grant dates were analyzed, of which one grant date received a V flag and no grant dates were at monthly lows. The result of this third analysis was not statistically significant.

These results, in conjunction with the initial document review, supported the Independent Review’s determination that a sample population of the grants could not be relied upon and instead a review of all grants would be necessary.

In addition, the results of the statistical analysis, in conjunction with emails and interviews, were consistent with the notion that some grant dates appeared to have been chosen with the benefit of hindsight.

The principal findings of the Independent Review as publicly disclosed on February 14, 2007, and as updated through the date of this filing, are as follows:

 

   

Most options granted from April 1997 to June 2006 were approved via UWCs. The Company used the effective date on the UWC as the grant date, and as per the Company’s stock option plans used the closing price of the trading day immediately prior to the grant date as the exercise price for the options. During that time period, the majority of grants were not final as of the effective date stated on the face of the UWC. As a result, the grant date recorded by the Company was not the appropriate accounting measurement date, resulting in compensation expense that, in most instances, was not recorded;

 

   

With respect to a number of grants, most made on or prior to February 5, 2003 when certain structural changes were made to the stock option granting process, some members of senior management appear to have chosen grant dates with the benefit of hindsight. These grants were approved by CEO execution of UWCs. The UWC approving such grants reflects the chosen date of the grant rather than the date of the approval. As a result, the grant date recorded by the Company was not the appropriate accounting measurement date, resulting in compensation expense that, in most instances, was not recorded;

 

   

Prior to November 2004, administrative errors prevented some stock option grants from being approved in a timely fashion. These errors were subsequently remedied by providing the affected employees with grants effective as of the date the grant would have occurred had no errors been made. The grants were either made in a subsequent UWC or Board Resolution with an earlier “effective date” or by amendment to a prior UWC or Board Resolution. The appropriate accounting measurement date for these delayed grants was the date the grants were actually approved, not the earlier date. Recording the appropriate accounting measurement date in the majority of instances would have resulted in compensation expense, and in these instances the Company failed to record the required expense;

 

   

In certain instances, employees were permitted to begin a leave of absence (“LOA”) upon being hired, allowing the employees to receive a stock option grant and specific exercise price as of their hire date without providing service during the LOA. In these instances, generally accepted accounting principles (“GAAP”) requires compensation cost to be measured when the employee begins to provide service; however, the Company failed to do so and, as a result, failed to record the required expense;

 

   

For much of the period under review, departing employees frequently were given LOAs, separation agreements or termination agreements in lieu of or in addition to severance payments. For certain of these termination arrangements, it appears the purpose was to provide the employees extended option vesting and exercising privileges without requiring the grantee to provide any substantive future

 

49


Table of Contents
 

service. Under GAAP, such agreements constitute modifications to the original option grants and compensation expense must be re-measured. The Company failed to re-measure the compensation cost resulting from these options and to record the required compensation expense;

 

   

Certain employees were granted options that were later modified, or cancelled and thereafter reissued at a lower price. For a few of these grants, the purpose appears to have been to give the grantee a lower exercise price. Under GAAP this is a re-pricing that requires compensation expense to be recognized and, if it qualifies for variable accounting treatment (which would be the case for all re-pricings after the effective date of FASB Interpretation 44, Accounting for Certain Transactions Involving Stock Compensation (“FIN 44”), to be adjusted quarterly for as long as the re-priced option remains outstanding. In these instances, the Company failed to record this expense;

 

   

The actions described in the categories listed above were applicable broadly across the Company’s employee base; and

 

   

In some instances, grants were given to Section 16 officers on the approval of the CEO but without the approval of the Compensation Committee, as required by the Company’s stock option plan and Compensation Committee charter. The failure to have the Compensation Committee approve these grants did not result in an accounting consequence. The Board has now ratified these grants.

Stock Option Grant Analysis

The Company has organized its stock option grants into categories based on grant type and the process by which the grant was finalized. All option amounts and stock prices are adjusted for two 2:1 stock splits. The Company analyzed the evidence from the Audit Committee’s Independent Review related to each category including, but not limited to, physical documents, electronic documents, underlying electronic data about documents and witness interviews. In addition, all non-acquisition stock option grants in Equity Edge were compared with the corresponding authorizing documents. Based on the relevant facts and circumstances, the Company applied the applicable accounting standards in effect at that time to determine, for every grant within each category, the proper measurement date. If the measurement date was not the recorded grant date, accounting adjustments were made as required, resulting in stock-based compensation expense and related tax effects.

From January 1996, the beginning of the Review Period, through April 10, 1997, the day before the Company’s initial public offering (“IPO”), the Company made 763 grants totaling 28.1 million stock options on 21 authorizing documents. The Company concluded that the “cheap stock” charge recognized by the Company at the time of the IPO was an appropriate measurement of compensation expense related to pre-IPO options.

From April 11, 1997 through May 31, 2006, the Company made 37,817 grants totaling 194.7 million stock options on 312 authorizing documents. Based on the results of the Independent Review, the Company concluded that 35,449 individual grants totaling 174.8 million stock options to the Company’s rank-and-file employees, Section 16 officers, and Directors, or 93.7% of all grants in this period, required new measurement dates. Of the 35,449 grants with new measurement dates, the market value of the shares underlying 27,087, or 76.4%, grants on the new measurement dates was higher than the market value of the shares on the originally designated grant date, and thus gave rise to an aggregate incremental intrinsic value charge under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”). For the remaining 8,362 grants, the market value on the new measurement date was lower than the historical market value and there was no accounting impact. Of the 35,449 stock option grants requiring new measurement dates, 1,323 grants should also have been subject to variable accounting.

In June 2006, the Company made 149 grants totaling 1.1 million stock options on three authorizing documents. The Independent Review included these grants within the scope of its review. The Company concluded that due to changes in the Company’s processes beginning June 2006, these grants were properly accounted for.

 

50


Table of Contents

Since the Company concluded that stock option grants in the time periods of January 1996 through April 10, 1997 and periods subsequent to May 31, 2006 were properly accounted for, the Company has focused its analysis on the time period from April 11, 1997 through May 31, 2006. The Company separated its stock option grant analysis, for those grants between April 11, 1997 and May 31, 2006, into two distinct time periods based on the processes that the Company had in place during those time periods, as follows.

Stock Option Grants from April 11, 1997 through February 5, 2003. During this period, the number of Company employees grew from approximately 600 to almost 3,100. To support this rapid growth and to achieve its recruiting and retention objectives, the Company relied heavily on its equity award programs as a recruiting and retention tool. The Company’s practice was to grant stock options to almost all full-time employees worldwide in connection with their joining the Company. Furthermore, employees generally received additional option grants over the course of their employment.

From April 11, 1997 through February 5, 2003, the Company utilized 208 authorizing documents granting 22,785 individual grants for an aggregate of 134.9 million stock options. Included in these figures are 44 individual grants covering 533,601 stock options made during this period for which the Company found no authorizing document (although the grants are reflected in Equity Edge). The Company has fulfilled its obligation for those grants that were exercised, and the Company has an obligation to fulfill for those grants that have not yet been exercised. In addition, the Board has now ratified these grants for which no authorizing document was found. The Company has concluded that of the 22,785 aforementioned individual grants totaling 134.9 million stock options to the Company’s rank-and-file employees, Section 16 officers, and Directors, 22,218 individual grants totaling 125.0 million stock options required new measurement dates; the remaining 567 grants, all of which were granted on Exhibit As (as described below) did not require new measurement dates.

The Company’s primary method for granting stock options was by UWC executed by the CEO, and a secondary method was by means of a schedule, known as an Exhibit A (“Exhibit A”), presented and approved at Board meetings. Unless otherwise indicated on an authorizing document, the Company measured compensation cost based on the printed or typewritten effective date on the UWC or the Board meeting date for Exhibit As.

On June 9, 1997, the Board delegated to Mr. William Coleman, the Company’s Chairman of the Board and CEO from inception of the Company through October 1, 2001 (“Mr. Coleman”), the authority to grant stock options to employees. The date of the first UWC Mr. Coleman approved under this delegation was June 26, 1997. From January 1, 1996, and prior to the June 26, 1997 UWC, stock options were granted primarily via Board Resolution with Exhibit As. Though the Board had delegated authority to the CEO on June 9, 1997, the Company continued to execute grants that were in proximity to Board meetings by obtaining approval of the Board. On October 2, 2001, Mr. Alfred Chuang (“Mr. Chuang”) succeeded Mr. Coleman as CEO and assumed authority to approve grants by UWC.

Once prepared by an human resources representative, a UWC, which included details of individuals and the number of stock options for each individual, was typically hand delivered to the CEO for approval and his signature. There was no electronic signature process during this time. Additionally, on a majority of UWCs, the CEO did not date his signature. In those cases where the former CEO did date his signature, various facts and circumstances indicate the unreliability of these signature dates. Further evidence suggests that some UWCs were not presented to the CEO for signature until after the purported effective date. During this time, there was no formal electronic archiving of authorizing documents, and electronic templates appear to have been used for multiple grants.

Though the practice of the Company was to assign an effective date to a UWC and, unless otherwise indicated, to use that date as the grant date, the Company found numerous instances of changes made to UWCs after the purported effective date. These changes were (1) to a UWC after its purported effective date but prior to its being signed, and (2) to a signed UWC. Therefore, the Company concluded that the purported effective date on a UWC could not be relied upon as definitive evidence of finality. Since the CEO signature on the majority of

 

51


Table of Contents

UWCs was not dated, and since in the few instances where the signature was dated other evidence suggests that this date was not reliable, the Company also concluded that there was not sufficient evidence to determine the date of signature of the final version of the UWCs, and it was therefore inappropriate to use the date of signature as the new measurement date.

Historically, UWCs were not prepared on a given schedule, but were issued as often as several times per week. In May 2001, the Company initiated a process of issuing a UWC on a set schedule of every other Wednesday. Though UWCs were prepared with effective dates using this set schedule, the same issues discussed in the above paragraph regarding lack of finality of the UWC as of the purported effective date continued to exist. Notwithstanding this schedule, there were 15 UWCs with effective dates other than a scheduled UWC date, of which 11 were annual company-wide merit grants or retention grants and four were new hire grants.

In addition, during this period (April 11, 1997 through February 5, 2003) the Board approved grants on Exhibit As for grants that were in proximity to Board meetings. The process was generally as follows: the Board approved by Resolution an aggregate number of options and would reference an Exhibit A. The Exhibit A was a standard inclusion in the information binders distributed before or at each Board meeting, and Exhibit As listed each individual grantee and the corresponding number of options.

Throughout this period, the Company’s stock administration function entered the option grant information for approved grants into Equity Edge. Once input to Equity Edge, notifications were sent to employees. Due to personnel turnover and a lack of extrinsic evidence, the available documentation to validate the various historical notification processes was sparse, but evidence suggests in all instances the grant notifications were subsequent to the entry of the information into Equity Edge. In addition, once input to Equity Edge, the grant data was subsequently sent to the Company’s designated broker(s) that employed online stock option tracking features. Data could only be viewed by employees using the online features for stock option tracking. For the online brokers, the data was exported to the broker through Equity Edge, and it appears that stock administration would export the data within a couple of weeks of entering the grant to Equity Edge.

Options were granted primarily to three categories of individuals: (1) rank-and-file employees, (2) Section 16 officers, and (3) Directors. The Company made grants for a variety of different reasons and primarily characterized them as (1) grants to new and existing employees, both rank-and-file employees and Section 16 officers, for new hires, promotions and other compensation adjustments, as well as grants to Directors; (2) annual merit grants; and (3) retention grants. In one instance, options were granted to an external consultant under the 1997 Stock Incentive Plan. This grant was not appropriately accounted for at the time under the applicable accounting guidance.

Administrative errors prevented some option grants from being approved in a timely fashion. These errors appear to be primarily related to grants that had not been timely processed, primarily in the period when these processes were manual. These errors were subsequently remedied by providing the impacted employees with grants effective as of the date the Company believed the grants should have been made as opposed to the effective date designated on the authorizing document. These grants were made either on a subsequent UWC or Exhibit A with a specified grant date that was different than and prior to the effective date of the UWC or Exhibit A on which the grant was included. It appears that at least one grant date of November 1, 1999, which was identified on seven subsequent UWCs and two subsequent Exhibit As, may have been chosen with the benefit of hindsight. From April 11, 1997 through February 5, 2003, the Company recorded 1,871 stock option grants, out of a total of 22,785 stock option grants, with a grant date prior to the effective date of the corresponding UWC or Exhibit A.

APB 25 defines the measurement date for determining stock-based compensation expense as the first date on which both (1) the number of shares that an individual employee is entitled to receive, and (2) the option or purchase price, are known. For grants made in this period (April 11, 1997 through February 5, 2003) for which there is reliable evidence, primarily Board or Compensation Committee approval, supporting a measurement date

 

52


Table of Contents

under APB 25, the Company used the date of reliable evidence as the new measurement date. For those grants made in this period where there is no reliable evidence supporting an earlier measurement date under APB 25, the Company has determined that the date the stock option was entered into the Company’s E*Trade Equity Edge™ stock administration database is the appropriate new measurement date. Throughout this period, the Company’s stock administration function entered the option grant information for approved grants into Equity Edge, and the median time difference between the effective date of a UWC and the subsequent entry into Equity Edge was 13 days. Using these new measurement dates, and after accounting for forfeitures, the Company has recognized incremental stock-based compensation expense of $242.8 million on a pre-tax basis over the respective options’ vesting terms.

Stock Option Grants from February 6, 2003 through May 31, 2006. During this period, the number of Company employees increased to approximately 4,000 from less than 3,100; approximately 60% of this net increase was as a result of acquisitions. Though stock options were still a key recruiting and retention tool, the volume of options granted had declined significantly as compared to the earlier period.

From February 6, 2003 through May 31, 2006, the Company utilized 104 authorizing documents awarding 15,032 individual grants for an aggregate of 59.8 million stock options. Unlike the prior period, authorizing documents were identified for all grants made during this period. The Company has concluded that of the 15,032 individual grants totaling 59.8 million stock options to the Company’s rank-and-file employees, Section 16 officers, and Directors during this period, 13,231 individual grants totaling 49.8 million stock options required new measurement dates.

In February 2003, the Company implemented a new stock option granting process, which was approved by the Compensation Committee. The new process required multiple signatures to authorize a UWC. For stock option grants to rank-and-file employees, signatures from the CEO and one Compensation Committee member were required to authorize the grants. For stock option grants to Section 16 officers and Directors, signatures from the CEO, inside counsel, and two Compensation Committee members were required to authorize the grants. During this period, the Compensation Committee was composed of either two or three members.

The new process continued the practice of issuing a UWC on every other Wednesday, although not all UWCs were finalized by the purported effective date. Notwithstanding this schedule, there were 11 UWCs with an effective date other than a scheduled UWC date, of which nine were annual company-wide merit grants or retention grants and two were new hire grants. Even though the new process required UWCs to be approved by multiple signatories, the Company continued to use the printed or typewritten effective date on the UWC, not the date of the last required signature, as the grant date unless otherwise indicated on the UWC. Under the new process, the Company’s practice was that the inside counsel and the CEO signed the UWC on the same day or prior to obtaining the required signatures from the Compensation Committee members.

Administrative errors continued to prevent some option grants from being approved in a timely fashion. During this period from February 6, 2003 through May 31, 2006, the Company recorded 43 stock option grants with a grant date prior to the effective date of the corresponding UWC or Exhibit A. During this period from February 6, 2003 through May 31, 2006, the date of the last known occurrence of these administrative errors was on a UWC dated January 2005. By November, 2003, the Company had developed systemic business processes worldwide through its Peoplesoft ERP system that mitigated the occurrence of such administrative errors, as only one such instance occurred after this date.

In this period (February 6, 2003 through May 31, 2006), the Company has concluded that its receipt of the last required signature where the dated signature is determined to be reliable is the appropriate new measurement date for calculating additional stock-based compensation expense under APB 25. Using these measurement dates, and after accounting for forfeitures, the Company has recognized incremental stock-based compensation expense of $3.7 million on a pre-tax basis over the respective options’ vesting terms.

 

53


Table of Contents

Five Measurement Date Rules. The Company has taken the position that, with respect to option grants for which the recorded measurement date was not supported by sufficient evidence of finality and therefore not accounted for properly, the appropriate new measurement date may be established in one of five ways:

(1) When there is evidence of Board or Compensation Committee approval, the Board or Compensation Committee approval or meeting date is the new measurement date;

(2) For the period from February 6, 2003 through May 31, 2006 when the dated signatures on a UWC are determined to be reliable, the date of last required signature on the UWC, or if the signature is not dated, the fax return date, is the new measurement date;

(3) For the period from April 11, 1997 through February 5, 2003 when the dated signature on and purported effective date of the UWC are determined to not be reliable, the Equity Edge entry date is the new measurement date;

(4) For the period from April 11, 1997 through February 5, 2003 when the dated signature on and purported effective date of the UWC are determined to not be reliable, but where other evidence exists to demonstrate that finality occurred prior to the Equity Edge entry date, the date of reliable grant information is the new measurement date. In this circumstance, the Company found emails, employee correspondence, and Equity Edge grant information related to 344 grants that supported the fact that these grants had been previously entered into Equity Edge and subsequently re-entered to adjust only the tax designation of the options (incentive versus nonqualified stock options). The Company concluded that since no other attribute of the grant was changed, the initial entry into Equity Edge, which was commensurate with the other grants on the related authorizing document, was the most appropriate new measurement date;

(5) When the grant date is prior to the employee providing services to the Company, the first day of work is the new measurement date.

Summary of Stock-Based Compensation Recognized due to New Measurement Dates. Below is a summary of the stock-based compensation, net of forfeitures, recognized by the Company by measurement date rule:

 

Type

   Number of grants
requiring new
measurement date
    Total Number of
options
   Compensation
expense, net of
forfeitures
           (Amounts in thousands)

April 11, 1997 through February 5, 2003

       

1) Equity Edge entry date

   20,754     99,559    $ 204,004

2) Board approval

   486     21,253      28,208

3) Reliable evidence prior to Equity Edge entry date

   344     1,288      6,946

4) Date employee began services

   9     474      3,587
                 

Subtotal

   21,593     122,574      242,745

February 6, 2003 through May 31, 2006

       

5) Last required signature on a UWC

   12,533     47,164      3,727
                 

Total

   34,126 *   169,738    $ 246,472
                 

* Does not include those grants subject to variable accounting or other adjustments described below.

 

54


Table of Contents

In addition, below is a summary of the stock-based compensation recognized, net of forfeitures, by the Company by rank-and-file employees, Section 16 officers, and Directors:

 

Amounts in thousands

   Year Ended January 31,
   1998    1999    2000    2001    2002

Rank-and-file employees

   $ 143    $ 1,683    $ 6,244    $ 30,043    $ 40,093

Section 16 officers

     —        76      2,881      16,805      18,964

Directors

     —        —        25      430      1,142
                                  

Total Fixed Awards, net of forfeitures

   $ 143    $ 1,759    $ 9,150    $ 47,278    $ 60,199
                                  

Amounts in thousands

   Year Ended January 31,
   2003    2004    2005    2006    Total

Rank-and-file employees

   $ 36,147    $ 28,259    $ 13,652    $ 7,370    $ 163,634

Section 16 officers

     22,551      10,607      4,988      2,522    $ 79,394

Directors

     998      630      157      62    $ 3,444
                                  

Total Fixed Awards, net of forfeitures

   $ 59,696    $ 39,496    $ 18,797    $ 9,954    $ 246,472
                                  

Stock Option Grants Subject to Variable Accounting

National Insurance Contribution (“NIC”) Tax. The Company has also concluded that certain of its stock options grants are subject to variable accounting.

In May 2001, the Company modified its stock option grant agreements in the United Kingdom (“U.K.”) to transfer the Company’s National Insurance Contribution (“NIC”) tax liability to employees. In conjunction with its modified stock option agreements, the Company and its U.K. employees executed Joint Election Forms pursuant to which the parties agreed to pass the Company’s NIC tax liability to the employees, which in turn enabled the employees to obtain tax relief against their taxable income from the U.K. taxing authorities. Pursuant to applicable U.K. tax requirements, the Company did not utilize the modified stock option agreements and Joint Election Forms until it had received approval from relevant U.K. taxing authorities.

Although the Company’s stock administration function implemented the appropriate NIC tax withholding upon exercise of a U.K. employee’s stock options subject to the tax transfer, the Company’s local payroll department mistakenly reimbursed the withheld amount to each employee in a subsequent payroll cycle. The Company continued this practice through August 22, 2006. The Company has concluded that, per EITF Issue No. 00-23, Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No. 44 (“EITF 00-23”), because the Company in substance provided the employee with a cash bonus tied to the intrinsic value of the options upon exercise, the exercise price of these options was not fixed, and the Company must apply variable accounting to each stock option granted to employees in the U.K. in the period in which the Company maintained this practice. Accordingly, 1,413 grants totaling 5.0 million stock options granted from May 1, 2001 through January 31, 2006 were subject to variable accounting. The Company has recognized net incremental stock-based compensation expense of $4.3 million, net of forfeitures and adjustments to remeasure the award at intrinsic value, on a pre-tax basis through January 31, 2006.

On August 22, 2006, the Company ceased reimbursing employees for the NIC tax liability. On that date, the awards were effectively modified. However, because the Company was subject to the requirements of FAS 123(R) on that date, and because the modification reduced the fair value of the options, the modification did not have an accounting consequence.

Other Variable Awards. In addition, the Company concluded that one grant of 400,000 stock options in fiscal year 2000 to a former Section 16 officer was subject to variable accounting due to the terms and conditions of that grant. The former Section 16 officer asserted this grant as originally priced had an incorrect exercise price. Rather than re-price the stock options, the Company offered him a cash bonus payable upon exercise of the

 

55


Table of Contents

vested stock options (in effect a re-pricing under FIN 44). At the time of the agreement, the Company accrued the intrinsic value of the cash bonus and amortized the expense over the vesting period of the stock options, but did not account for the stock option grant as a variable award.

The Company has recognized net stock-based compensation expense of $3.4 million, net of forfeitures, on a pre-tax basis through the first quarter of fiscal year 2004, which is the fiscal period in which this variable award ceased based on the termination of the Section 16 officer.

Stock Option Grant Modifications Related to Current and Terminated Employees

Grant Modifications-Terminated Employees. For much of the period under review, departing employees frequently were given separation agreements, termination agreements, or leaves of absence in lieu of or in addition to severance payments. Typically, such arrangements related to the Company (1) permitting employees additional time to vest their stock options following their cessation of services to the Company; and (2) permitting employees additional time to exercise their stock options, beyond the period of time provided for such exercises under the employees’ stock option grant agreement. Such arrangements constitute modifications to the original option grants and compensation expense must be recognized in the period of the modification, which the Company did not do.

The Company analyzed the circumstances surrounding all 5,148 terminations from April 1997 through June 2006, which included the review of 1,273 termination agreements, of which eight were for Section 16 officers. The Company concluded that the terms and conditions of 975 termination agreements, eight of which were for Section 16 officers, resulted in modifications of the underlying stock options. Although these arrangements embody the terms and conditions of the termination of the employee from the Company, the Company did not have adequate business processes to ensure that the terms and conditions of such arrangements were communicated to the accounting and finance personnel for appropriate consideration. The Company has recognized incremental stock-based compensation expense related to these modifications of $98.5 million on a pre-tax basis, $44.8 million related to the eight modifications for Section 16 officers and $53.7 million related to 967 modifications for rank-and-file employees.

In addition, the Company reviewed the termination data in the Company’s Peoplesoft ERP and Equity Edge for the remaining 3,875 terminations, including the terminations of eight Section 16 officers. The Company determined that 1,223 of such terminations resulted in modifications of the underlying stock options, of which three were for Section 16 officers. The Company did not have adequate business processes to ensure that data was accurately and consistently captured and entered to its Peoplesoft ERP and Equity Edge systems such that the resulting data input did not mistakenly result in a systemic extension of either vesting or the time period to exercise upon termination. The Company has recognized incremental stock-based compensation expense related to these modifications of $73.4 million on a pre-tax basis, $15.5 million related to the three modifications for Section 16 officers and $57.9 million related to 1,220 modifications for rank-and-file employees.

In total, the Company has recognized, and such recognition has taken place in the period of modification, incremental stock-based compensation expense associated with such modifications of $171.9 million on a pre-tax basis in the period of modification.

Grant Modifications-Active Employee. In some circumstances the Company modified grants to active employees. These modifications fall into four categories, and the total compensation expense associated with these modifications is $4.3 million, net of forfeitures, on a pre-tax basis.

In the first circumstance, employees who had properly entered a LOA were allowed to vest their stock options in circumstances where the Company’s policy did not permit such vesting. Such arrangements constitute modifications to the original option grants and compensation expense must be re-measured pursuant to FIN 44 in the period of modification, which the Company did not do. The Company has recognized incremental stock-

 

56


Table of Contents

based compensation expense associated with such modifications of $1.6 million on a pre-tax basis in the period of modification.

In the second circumstance, certain employees were (1) granted options, for five grants, that were subsequently cancelled and either immediately or shortly thereafter reissued at a lower price; (2) granted additional options, for five grants, immediately or shortly after an initial grant, at a lower price than the initial grant, and the initial grant was immediately or shortly thereafter cancelled; and (3) granted options, for 43 grants to 32 grant recipients, of which the Company concluded that 19 were modifications, that were subsequently modified through a change in price after the initial entry into Equity Edge. Under GAAP this cancellation and replacement is a re-pricing that requires compensation expense to be recognized and adjusted quarterly for as long as the re-priced option remains outstanding. The Company failed to record this expense. The Company has recognized incremental stock-based compensation expense associated with such modifications of $1.0 million, net of forfeitures, on a pre-tax basis in the period of modification.

In the third circumstance, there was one instance of a change in status of a Section 16 officer from a Director to a consultant. Upon a change of status to a consultant, compensation expense must be measured, which the Company did not do, pursuant to EITF Issue No. 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services relating to options that vest during the consulting period. The Company has recognized incremental stock-based compensation expense associated with this change of status of $1.3 million, net of forfeitures, on a pre-tax basis in the period of the change in status.

In the fourth circumstance, there was one instance of a change to the vesting schedule of a rank-and-file employee. Such an arrangement constitutes a modification to the original option grants and compensation expense must be recognized over the required service period, which the Company did not do. The Company has recognized incremental stock-based compensation expense associated with such a modification of $0.4 million, net of forfeitures, on a pre-tax basis commencing in the period of modification.

Employer and Employee Tax Liabilities Penalties and Interest

The Company identified numerous instances of stock options that were originally classified as incentive stock options (“ISOs”) that (1) due to the new measurement dates should have been non-qualified Stock Options (“NQSOs”) (“Reclassified”), and (2) due to termination and other modifications the unexercised stock options at modification date should have been NQSOs (“Modified”). In regards to Reclassified ISOs, a majority of the historical stock option grants that were issued as ISOs should have been NQSOs because due to the new measurement dates they were issued at a discount to fair market value (“FMV”). The difference between the FMV of the Company’s stock and the strike price on these Reclassified stock options at exercise date should have been subject to withholdings for income and employment taxes. In regards to Modified ISOs, the unexercised portion of the ISOs that were not already Reclassified due to new measurement dates should have been NQSOs at the time upon the modification, which included allowing terminated employees to continue to vest. The difference between the FMV of the Company’s stock and the strike price on these Modified stock options at exercise date should have been subject to withholdings for income and employment taxes.

The Company performed a grant-by-grant examination of all options requiring measurement date changes and calculated the requisite employment taxes that should have been accrued upon subsequent exercise of the ISOs that should have been NQSOs. The Company concluded that the liability for (1) under-withheld employee income taxes, (2) employer and employee-borne employment taxes; and (3) all respective interest and penalties should be recorded in the period these liabilities arose as evaluated under Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (“FAS 5”). However, for the fiscal years 1998 through 2003, the corresponding statute of limitations expired before the amounts were paid and therefore, the liabilities were reversed as the corresponding statute of limitations expired. The Company intends to assume the employees’ remaining obligations for these taxes.

 

57


Table of Contents

The total additional expense of these additional taxes, penalties, and interest, net of reversal due to the expiration of the respective statute of limitations, is $2.8 million on a pre-tax basis.

Internal Revenue Code Section 409A

Certain adjustments to the measurement dates of stock options that resulted in additional stock-based compensation expense also illuminated an additional and separate exposure for employee-borne taxes under Internal Revenue Code (“IRC”) Section 409A (“409A”). The tax is a 20% assessment on certain types of equity award income, including gains on discounted options. The state of California also assesses this tax. Because the Company’s employees were unaware of the tax at the time their options were granted and unaware that some options they received would subject them to these taxes, the Company entered into arrangements with both the U.S. Internal Revenue Service (“IRS”) and the state of California in February 2007 to discharge these obligations, on behalf of its employees, directly with the taxing authorities for all periods through December 31, 2006. The Company also paid the associated penalties and interest.

The Company concluded that the expense associated with discharging its employees’ 409A exposure for all periods through December 31, 2006 should be reflected in the Company’s first quarter of fiscal year 2008 financial statements since that is the period in which the Company made the decision to assume these obligations. The Company accrued $4.9 million on a pre-tax basis in the first quarter of fiscal year 2008 in estimation of the amount of these obligations.

In addition, the Company intends to provide its employees with the opportunity to remedy their outstanding stock options that are subject to potential penalties under 409A. The resulting financial impact will be reflected in the period in which the remedial action is finalized.

Purchase Accounting

Over the periods affected by the additional stock-based compensation expense, the Company made several business and asset acquisitions for which net deferred tax liabilities (“DTLs”) were recorded in purchase accounting for taxable temporary differences acquired and/or recorded in the purchase accounting. In connection with these acquisitions the Company was required to reduce its valuation allowance based on the DTLs recorded in the purchase accounting as they provided a source of future taxable income to recognize certain of the Company’s deferred tax assets (“DTAs”). Prior to the restatement, these reductions in the valuation allowance related entirely to excess stock option tax benefits and therefore they were accounted for with a credit directly to equity consistent with FAS No. 109, Accounting for Income Taxes (“FAS 109”) , paragraphs 36(e) and 37.

The additional stock-based compensation expense recognized as a result of revised measurement dates impacted the original purchase accounting in that a significant portion of the reduction in the Company’s valuation allowance reduced in connection with the relevant acquisitions are no longer excess stock option deductions. As a result, reductions in the Company’s valuation allowance in connection with the relevant acquisitions are accounted for as part of the acquisition purchase price (i.e., reductions in goodwill and, in certain circumstances, identifiable intangible assets) rather than as the recognition of excess stock option deduction benefits accounted for directly to equity.

Therefore, the reduction in goodwill and intangible assets as a result of the additional stock-based compensation reduced the related amortization of those intangibles by $11.4 million. Those intangible assets that were adjusted were fully amortized by January 31, 2006.

 

58


Table of Contents

Summary of Stock-Based Compensation Adjustments and Related Issues

The summary of the incremental stock-based compensation after considering forfeitures, and related issues on a pre-tax and after-tax basis for the fiscal years ended January 31, 1998 through 2006, and for the quarter ended April 30, 2006 is as follows:

 

Amounts in thousands

   Year Ended January 31,  
   1998     1999     2000     2001     2002  

Net income (loss) as reported

   $ (22,912 )   $ (51,582 )   $ (19,574 )   $ 17,082     $ (35,678 )

New Measurement Date Rules

     143       1,759       9,150       47,278       60,199  

Variable-NIC Tax

     —         —         —         —         495  

Variable-Other

     —         —         1,724       13,925       (9,909 )

Modifications-Terminated Employees

     491       1,045       17,048       99,334       44,169  

Modifications-Active Employees

     115       26       867       1,362       389  

Employment taxes

     78       153       965       23,226       14,056  

Purchase Accounting

     —         —         —         —         —    

Other

     —         —         —         —         —    
                                        

Increase/(Decrease) in operating expense

     827       2,983       29,754       185,125       109,399  
                                        

Increase/(Decrease) in tax provision

     —         —         —         (25,855 )     (9,052 )
                                        

Net income as restated

   $ (23,739 )   $ (54,565 )   $ (49,328 )   $ (142,188 )   $ (136,025 )
                                        

Amounts in thousands

   Year Ended January 31,    

Total

 
   2003     2004     2005     2006    

Net income as reported

   $ 83,876     $ 118,674     $ 131,056     $ 142,743     $ 363,685  

New Measurement Date Rules

     59,696       39,496       18,797       9,954       246,472  

Variable-NIC Tax

     900       2,357       (1,885 )     2,468       4,335  

Variable-Other

     (2,336 )     (43 )     —         —         3,361  

Modifications-Terminated Employees

     4,876       2,964       1,065       928       171,920  

Modifications-Active Employees

     71       119       1,444       (128 )     4,265  

Employment taxes

     4,878       2,785       (25,333 )     (14,928 )     5,880  

Purchase Accounting

     (1,462 )     (4,977 )     (4,563 )     (440 )     (11,442 )

Other

     —         —         (187 )     (616 )     (803 )
                                        

Increase/(Decrease) in operating expense

     66,623       42,701       (10,662 )     (2,762 )     423,988  
                                        

Increase/(Decrease) in tax provision

     (23,662 )     (32,063 )     (3,979 )     2,335       (92,276 )
                                        

Net income (loss) as restated

   $ 40,915     $ 108,036     $ 145,697     $ 143,170     $ 31,973  
                                        

The reduction in the tax provision for fiscal years 2001 and 2002 is limited by the need to increase the valuation allowance for deferred tax assets related to additional stock-based compensation deductions. The reduction in the tax provision for fiscal year 2005 is related to release of the Company’s valuation allowance. The increase in the tax provision in fiscal year 2006 is magnified as certain deductions are limited related to officer’s compensation, the deduction of which is subject to limitations under IRC 162(m).

Additionally, we have restated the pro forma expense under FAS 123 in Note 2 of the notes to Consolidated Financial Statements of this Form 10-K to reflect the impact of these adjustments for the years ended January 31, 2006 and 2005.

 

59


Table of Contents

The following tables present the impact of stock-based compensation and associated tax adjustments made to our previously reported balance sheet and statements of income:

Consolidated Balance Sheet as of January 31, 2006 (in thousands):

 

     January 31, 2006  
     As Reported     Adjustments     As Restated  

ASSETS

      

Current Assets:

      

Cash and cash equivalents

   $ 1,017,772     $ —       $ 1,017,772  

Restricted cash

     2,373       —         2,373  

Short-term investments

     370,763       —         370,763  

Accounts receivable, net of allowance for doubtful accounts of $9,350

     331,332       —         331,332  

Deferred tax assets

     28,396       —         28,396  

Prepaid expenses and other current assets

     52,093       —         52,093  
                        

Total current assets

     1,802,729       —         1,802,729  

Long-term investments

     64,422       —         64,422  

Property and equipment, net

     343,389       —         343,389  

Goodwill, net

     145,523       (7,288 )     138,235  

Acquired intangible assets, net

     78,502       —         78,502  

Long-term restricted cash

     2,644       —         2,644  

Long-term deferred tax assets

     28,987       —         28,987  

Other long-term assets

     9,335       —         9,335  
                        

Total assets

   $ 2,475,531     $ (7,288 )   $ 2,468,243  
                        

LIABILITIES AND STOCKHOLDERS’ EQUITY

      

Current liabilities:

      

Accounts payable

   $ 22,984     $ —       $ 22,984  

Accrued liabilities

     91,244       5,879       97,123  

Restructuring Obligations

     3,531       —         3,531  

Accrued payroll and related liabilities

     92,039       —         92,039  

Accrued income taxes

     82,234       871       83,105  

Deferred revenue

     379,123       —         379,123  

Convertible subordinated notes

     465,250       —         465,250  

Current portion of notes payable and other obligations

     218       —         218  
                        

Total current liabilities

     1,136,623       6,750       1,143,373  

Deferred tax liabilities

     1,283       —         1,283  

Notes payable and other long-term obligations

     227,388       —         227,388  

Convertible subordinated notes

     —         —         —    

Commitments and contingencies

      

Stockholders’ equity:

      

Preferred stock—$0.001 par value; 5,000 shares authorized; none issued and outstanding

     —         —         —    

Common stock—$0.001 par value; 1,035,000 shares authorized; 443,886 shares issued and 385,943 shares outstanding

     444       —         444  

Additional paid-in capital

     1,341,577       326,000       1,667,577  

Treasury stock, at cost—57,943 shares

     (478,249 )     —         (478,249 )

Accumulated deficit

     254,798       (331,714 )     (76,916 )

Deferred compensation

     (11,461 )     (8,324 )     (19,785 )

Accumulated other comprehensive income

     3,128       —         3,128  
                        

Total stockholders’ equity

     1,110,237       (14,038 )     1,096,199  
                        

Total liabilities and stockholders’ equity

   $ 2,475,531     $ (7,288 )   $ 2,468,243  
                        

 

60


Table of Contents

Consolidated Statements of Income for the years ended January 31, 2005 and 2006 (in thousands):

 

    Fiscal year ended January 31, 2006     Fiscal year ended January 31, 2005  
    As Reported     Adjustments     As Restated     As Reported     Adjustments     As Restated  

Revenues:

           

License fees

  $ 511,549     $ —       $ 511,549     $ 483,138     $ —       $ 483,138  

Services

    688,296       —         688,296       596,956       —         596,956  
                                               

Total revenues

    1,199,845       —         1,199,845       1,080,094       —         1,080,094  
                                               

Cost of revenues:

           

Cost of license fees

    39,946       (1,168 )     38,778       39,118       (4,816 )     34,302  

Cost of services

    218,496       (62 )     218,434       193,549       (2,978 )     190,571  
                                               

Total cost of revenues

    258,442       (1,230 )     257,212       232,667       (7,794 )     224,873  
                                               

Gross profit

    941,403       1,230       942,633       847,427       7,794       855,221  

Operating expenses:

           

Sales and marketing

    440,494       (2,725 )     437,769       406,601       (7,925 )     398,676  

Research and development

    182,251       (17 )     182,234       146,559       291       146,850  

General and administrative

    107,450       1,210       108,660       91,233       4,766       95,999  

Restructuring charges

    772       —         772       8,165       —         8,165  

Acquisition-related in-process research and development

    4,600       —         4,600       —         —         —    
                                               

Total operating expenses

    735,567       (1,532 )     734,035       652,558       (2,868 )     649,690  
                                               

Income from operations

    205,836       2,762       208,598       194,869       10,662       205,531  

Interest and other, net:

           

Interest expense

    (32,072 )     —         (32,072 )     (29,984 )     —         (29,984 )

Net gain on retirement of convertible subordinated notes

    667       —         667       —         —         —    

Interest income and other

    40,994       —         40,994       22,338       —         22,338  
                                               

Total interest and other, net

    9,589       —         9,589       (7,646 )     —         (7,646 )
                                               

Income before provision for income taxes

    215,425       2,762       218,187       187,223       10,662       197,885  

Provision for income taxes

    72,682       2,335       75,017       56,167       (3,979 )     52,188  
                                               

Net income

    142,743       427       143,170       131,056       14,641       145,697  

Other comprehensive income:

           

Foreign currency translation adjustments

    (10,960 )     —         (10,960 )     6,872       —         6,872  

Unrealized gain (loss) on available-for-sale investments, net of income taxes

    1,675       —         1,675       (4,252 )     —         (4,252 )
                                               

Comprehensive income

  $ 133,458     $ 427     $ 133,885     $ 133,676     $ 14,641     $ 148,317  
                                               
           

Net income per share:

           

Basic

  $ 0.37       —       $ 0.37     $ 0.32     $ 0.04     $ 0.36  
                                               

Diluted

  $ 0.36       —       $ 0.36     $ 0.32     $ 0.03     $ 0.35  
                                               

Shares used in computing net income per share:

           

Basic

    389,050       —         389,050       405,768       —         405,768  
                                               

Diluted

    397,850       (460 )     397,390       415,873       285       416,158  
                                               

 

61


Table of Contents

Judgment

In light of the significant judgment required in establishing revised measurement dates, alternate approaches to those used by us would have resulted in different compensation expense charges than those recorded by us in our restated financial statements. In those cases where the Company concluded that the Equity Edge entry date was the most appropriate new measurement date, we considered various alternate approaches. However, we concluded, based on a variety of factors, that none of the alternative approaches was as reliable as the Equity Edge entry date.

The Company prepared a sensitivity analysis on those grants where the specific timing of the approval or finality of a grant cannot be determined with certainty within a range of likely dates and for which the Company concluded that the Equity Edge entry date, or a date prior to the Equity Edge entry date when other reliable evidence was available, was the most appropriate new measurement date. Since the median time difference between the UWC effective date and the Equity Edge entry date was 13 days for those UWCs for which the Company used the Equity Edge entry date as the new measurement date, the Company concluded that this time difference was short enough such that the sensitivity analysis would be a useful indicator. Since the Company is asserting that finality occurred sometime between the UWC effective date and the Equity Edge entry date, but that it has no evidence to identify the actual date, the Company chose to perform separate sensitivity analyses on the highest and lowest stock prices between the UWC effective date and the Equity Edge entry date. The Company performed this analysis for the 21,098 grants for which the Equity Edge entry date was used as the new measurement date. The result of the sensitivity analysis by fiscal year, after considering the effect of forfeitures, is presented below:

 

Amounts in thousands

  Year Ended January 31,
  1998   1999   2000   2001   2002

Compensation expense-Low Stock Price between UWC effective date and Equity Edge entry date

  $ 61   $ 353   $ 3,262   $ 16,699   $ 19,419

Compensation expense-Recognized

    143     1,759     9,150     47,278     60,199

Compensation expense-High Stock Price between UWC effective date and Equity Edge entry date

    181     2,707     12,084     68,627     91,797
    Year Ended January 31,    
    2003   2004   2005   2006   Total

Compensation expense-Low Stock Price between UWC effective date and Equity Edge entry date

  $ 21,099   $ 15,390   $ 8,411   $ 5,876   $ 90,570

Compensation expense-Recognized

    59,696     39,496     18,797     9,954     246,472

Compensation expense-High Stock Price between UWC effective date and Equity Edge entry date

    85,039     62,294     24,663     11,210     358,602

The Company believes that the approaches it used were the most appropriate under the circumstances.

Remedial Actions

As a result of its findings, the Audit Committee has made numerous recommendations regarding remedial action, all of which have been approved by the Board of Directors, including:

 

   

The Compensation Committee of the Board of Directors will be reconstituted and, in conjunction with the Audit Committee and its advisors will create a new Compensation Committee charter and new stock option granting process to ensure that the practices identified above will not occur in the future.

 

   

The Human Resources department will be restructured, and a new Human Resources leader has been recruited. The former Senior Vice President of Human Resources has left the Company. She voluntarily re-priced her outstanding mis-priced options to the price associated with the correct

 

62


Table of Contents
 

measurement dates as determined by the Audit Committee. In addition, two other senior employees in the Human Resources department who were involved in the stock option granting and stock administration processes voluntarily re-priced their outstanding mis-priced stock options to the price associated with the correct measurement dates of those grants as determined by the Audit Committee.

 

   

The office of the General Counsel will be strengthened by providing that the position will be filled with a new executive officer who reports directly to the CEO and who also has a reporting responsibility to the Board’s Nominating and Governance Committee. It is expected that the new General Counsel will possess substantial experience with compliance issues. The former General Counsel voluntarily re-priced his outstanding mis-priced stock options to the price associated with the correct measurement dates of those grants as determined by the Audit Committee. He remains at BEA as a vice president in the legal department.

 

   

William Klein, who served as Chief Financial Officer from February 2000 through February 2005 and has served as Executive Vice President of Business Planning and Corporate Development since 2005, voluntarily repaid BEA all after-tax gains he realized on options resulting from mis-pricings, as determined by the Audit Committee. On a pre-tax basis, Mr. Klein had realized approximately $34,000 of such gains. Mr. Klein also voluntarily re-priced his outstanding mis-priced options to the prices determined by the Audit Committee as the correct price for each of his grants. Mr. Klein remains at BEA in the position of Vice President of Business Planning and Corporate Development.

 

   

Mark Dentinger, who has served as Executive Vice President and Chief Financial Officer since February 2005, voluntarily re-priced all of his outstanding mis-priced options to the prices determined by the Audit Committee as the correct price for each of his grants.

 

   

Alfred Chuang, who has served as Chief Executive Officer since October 2001, realized a pre-tax gain of approximately $2.45 million related to the mis-pricing of stock options granted to him in 1998 and 1999, grants that were approved at least two years prior to his becoming the Chief Executive Officer. Although Mr. Chuang was not responsible for the mis-pricing of these grants, the Audit Committee and the Board of Directors determined that Mr. Chuang should return to BEA the benefit he realized from the mis-pricing. Accordingly, in order to effectuate this, Mr. Chuang and BEA entered into an agreement cancelling outstanding options to purchase 423,605 shares of BEA common stock. In addition, Mr. Chuang voluntarily re-priced his outstanding mis-priced options to the appropriate prices as determined by the Audit Committee.

 

   

William Coleman, who served as the Company’s Chief Executive Officer from 1995 through October 2001, voluntarily repaid BEA the after-tax gains he realized on exercises of options that the Audit Committee determined were originally mis-priced. On a pre-tax basis, the amount of such gain was approximately $260,000.

 

   

All current independent directors of the Company who have received options that were mis-priced voluntarily re-priced all such outstanding options to the price associated with the correct measurement dates, as determined by the Audit Committee. None of these directors has realized any gain from the exercise of any mis-priced options.

 

   

As a result of the remedial actions, the exercise price of currently outstanding options held by the directors and officers described above will increase, in the aggregate, approximately $23 million.

Following the review, the Audit Committee and the Board of Directors expressed their continued confidence in the leadership and integrity of Mr. Chuang and the current Executive Leadership Team.

 

63


Table of Contents

Related Matters before the SEC

On August 16, 2006, the Company announced that the Audit Committee would conduct an independent review of the Company’s stock option grants. Beforehand, the Company contacted the Securities and Exchange Commission’s (“SEC’s”) San Francisco District Office to advise the SEC Staff that such announcement would be forthcoming.

On September 11, 2006, the Company received a letter from the SEC Staff requesting the voluntary production of certain information in connection with an informal SEC Staff inquiry regarding Company option grants. On December 12, 2006, the Company received a letter from the SEC Staff requesting that the Company preserve all documents relating to the Company’s historical stock option grants and related accounting matters. On March 1, 2007, the Company received a supplemental request for the voluntary production of certain additional information relating to Company stock option grants and the Company’s pending restatement. Counsel for the Company and counsel for the Audit Committee have provided the requested materials to the SEC Staff and intends to continue to cooperate fully with the Staff inquiry. To that end, counsel for the Audit Committee and the Company have met with and/or communicated with the SEC Staff on a number of occasions regarding the status, findings, and conclusions of the Independent Review.

Status of Nasdaq Listing

On August 17, 2007, the Company received a letter from the Board of Directors of the NASDAQ Stock Market LLC (the “Nasdaq Board”) informing the Company that the Nasdaq Board has called for review the July 9, 2007 decision of the Nasdaq Listing and Hearing Review Council (the “Listing Council”), and determined to stay, pending further review by the Nasdaq Board, the Listing Council’s decision to suspend the Company’s common stock from trading on The Nasdaq Global Select Market. The Listing Council had previously determined to suspend the Company’s securities from trading on August 23, 2007 if the Company did not file its delayed quarterly and annual reports with the Securities and Exchange Commission by August 21, 2007. On September 14, 2007, the Company received a letter from the Nasdaq Board informing the Company that the Nasdaq Board had determined to grant the Company until November 14, 2007 to file all delinquent periodic reports necessary for the Company to regain compliance with its Nasdaq filing requirements. On November 9, 2007, the Company received a letter from the Nasdaq Board informing the Company that the Nasdaq Board had determined to grant the Company until January 9, 2008 to file all delinquent reports necessary for the Company to regain compliance with its Nasdaq filing requirements.

 

64


Table of Contents

Results of Operations

The following table sets forth certain line items in BEA’s consolidated statements of income as a percentage of total revenues for the fiscal years ended January 31, 2007, 2006, and 2005.

 

     Fiscal year ended January 31,  
     2007    

2006

As Restated(1)

   

2005

As Restated(1)

 

Revenues:

      

License fees

   40.9 %   42.6 %   44.7 %

Services

   59.1     57.4     55.3  
                  

Total revenues

   100.0     100.0     100.0  

Cost of revenues:

      

Cost of license fees(2)

   11.2     7.6     7.1  

Cost of services(2)

   32.5     31.7     31.9  
                  

Total cost of revenues

   23.8     21.4     20.8  
                  

Gross margin

   76.2     78.6     79.2  

Operating expenses:

      

Sales and marketing

   37.4     36.5     36.9  

Research and development

   16.6     15.2     13.6  

General and administrative

   9.9     9.1     8.9  

Restructuring charges

   —       0.1     0.8  

Acquisition-related in-process research and development

   0.3     0.3     —    

Impairment of land

   14.4     —       —    
                  

Total operating expenses

   78.6     61.2     60.2  
                  

Income from operations

   (2.4 )   17.4     19.0  

Interest and other, net

   3.2     0.8     (0.7 )
                  

Income before provision for income taxes

   0.8     18.2     18.3  

Provision for income taxes

   0.5     6.3     4.8  
                  

Net income

   0.3 %   11.9 %   13.5 %
                  

(1) See the “Explanatory Note” immediately preceding Part I, Item 1 and Note 2, “Restatement of Consolidated Financial Statements,” in Notes to Consolidated Financial Statements of this Form 10-K.

 

(2) Cost of license fees and cost of services are stated as a percentage of license fees and services revenue, respectively.

Revenues (in thousands):

 

     Fiscal year ended January 31,   

Percentage
change
fiscal 2007
vs.

fiscal 2006

   

Percentage
change
fiscal 2006
vs.

fiscal 2005

 
     2007    2006    2005     

Total revenues

   $ 1,402,349    $ 1,199,845    $ 1,080,094    16.9 %   11.1 %

Our revenues are derived from fees for software licenses and services. Services revenues are comprised of customer support and maintenance, education and consulting. Management believes total revenue growth for fiscal 2007 compared to fiscal 2006 was due to a continued demand for our WebLogic and Tuxedo product families and an increased demand for our new product family AquaLogic. The AquaLogic product family is comprised of products that were organically developed (e.g., AquaLogic Service Bus introduced in August 2005) and products acquired through the purchase of Plumtree Software Inc. (“Plumtree”) in October 2005 and Fuego Inc. (“Fuego”) in February 2006.

 

65


Table of Contents

Total revenue growth from fiscal 2006 to fiscal 2007 was 16.9 percent, which was comprised of a 20.4 percent increase in services and a 12.1 percent increase in licenses. The increase in services revenues was primarily due to customer support and maintenance revenues.

Revenue growth from fiscal 2005 to fiscal 2006 was 11.1 percent, which was comprised of a 15.3 percent increase in services and a 5.9 percent increase in licenses. Management believes revenue growth was driven by the increased demand for our products, primarily our WebLogic product family and the introduction of our new product family, AquaLogic. The continued growth in customer support and maintenance revenue was driven primarily by maintenance renewals on our existing installed base of software licenses, including the Plumtree installed base that was acquired, as well as maintenance contracts sold together with new sales of software licenses.

In fiscal 2006 and fiscal 2007 we acquired seven software companies, one of which was Plumtree, a public company that had established license and services revenues. We reflected 10 days of total revenue related to Plumtree in the third quarter of fiscal 2006 of approximately $1.0 million and a full quarter of revenue in the fourth quarter of fiscal 2006. Consequently, comparisons between fiscal 2007 and fiscal 2006 are impacted by this acquisition.

Geographically, the contribution of the Americas (U.S., Canada, Mexico and Latin America) to total revenues increased to 53.6 percent in fiscal 2007 compared to 51.9 percent in fiscal 2006. The Europe, Middle East and Africa (“EMEA”) contribution declined slightly to 31.8 percent in fiscal 2007 compared to 33.1 percent in fiscal 2006, and the Asia/Pacific (“APAC”) contribution decreased to 14.6 percent in fiscal 2007 compared to 15.0 percent in fiscal 2006. Management believes the revenue acquired with the Plumtree acquisition impacted the geographic results because the majority of the revenue acquired with Plumtree was generated in the United States. Exchange rates positively impacted total revenues for fiscal 2007 compared to fiscal 2006. Total revenues when translated at constant exchange rates from the same period in the prior year would have been approximately $1.4 billion, which represents a 16.0 percent increase over total revenues for the same period in the prior year versus a 16.9 percent absolute increase.

Geographically, the Americas contribution to total revenues increased to 51.9 percent in fiscal 2006 compared to 49.7 percent in fiscal 2005. The EMEA contribution declined slightly to 33.1 percent in fiscal 2006 compared to 35.5 percent in fiscal 2005 and the APAC contribution increased to 15.0 percent in fiscal 2006 compared to 14.8 percent in fiscal 2005. In addition, fiscal 2006 revenues did not benefit from fluctuations in exchange rates when compared to fiscal 2005.

License fees (in thousands):

 

     Fiscal 2007    Fiscal 2006    Fiscal 2005   

Percentage
change
fiscal 2007
vs.

fiscal 2006

   

Percentage
change
fiscal 2006
vs.

fiscal 2005

 

License fees

   $ 573,470    $ 511,549    $ 483,138    12.1 %   5.9 %

Management believes license revenue growth from fiscal 2006 to fiscal 2007 was due to continued demand for the WebLogic and Tuxedo product families and was driven by increased demand for our new product family, AquaLogic. The AquaLogic product family is comprised of products that were organically developed (e.g., AquaLogic Service Bus introduced in August 2005) and products acquired from Plumtree and Fuego. The AquaLogic product family contributed approximately 20 percent of revenues for fiscal 2007 compared to less than 10 percent for fiscal 2006. This is due in part to the fact that Plumtree was acquired late in the third quarter of fiscal 2006 and Fuego was acquired in the first quarter of fiscal 2007. Due primarily to the structure of our multi-product enterprise license agreements, our break down of product family license revenue is based on estimated demand at the time the order is placed, not necessarily on actual deployment. Exchange rates positively

 

66


Table of Contents

impacted license revenues for fiscal 2007 compared to fiscal 2006. In fiscal 2007, license revenues when translated at constant exchange rates from the same period in the prior year would have been approximately $567.9 million, which represents an 11.0 percent increase over license revenues for the same period in the prior year, versus a 12.1 percent absolute increase.

Quarterly revenue contribution from transactions with license fees greater than $1 million has ranged from approximately 23 to 39 percent of total license fees over the past eight quarters. Transactions greater than $1 million constitute a significant portion of total license revenues and management believes these transactions have an inherent volatility related to the timing and size of such transactions, which increases the risk that reported results may differ from expected results.

Management believes the increase in license revenues from fiscal 2005 to fiscal 2006 was due to improved demand for our core WebLogic product family and market acceptance of the new AquaLogic product family. The AquaLogic product family is comprised of products that were organically developed (e.g., AquaLogic Service Bus introduced in August 2005) and products acquired from Plumtree in the third quarter of fiscal 2006. Quarterly revenue contribution from transactions with license fees greater than $1 million was within the range of 22 percent to 40 percent for fiscal 2006 and there were no individual transactions with a license value greater than $10 million during fiscal 2006. Lastly, foreign exchange rates did not have a significant impact on fiscal 2006 compared to fiscal 2005.

In addition to the transactions with license fees greater than $1 million, we have a significant number of small and midsize deals. Our business model generally begins with smaller deals being seeded into our customers with a goal that these customers will enter into larger, more significant transactions over time.

Services revenue

The following table provides a summary of services revenue (in thousands):

 

     Fiscal 2007    Fiscal 2006    Fiscal 2005   

Percentage
change
fiscal 2007
vs.

fiscal 2006

   

Percentage
change
fiscal 2006
vs.

fiscal 2005

 

Consulting and education revenues

   $ 175,665    $ 145,572    $ 134,371    20.7 %   8.3 %

Customer support and maintenance revenues

     653,214      542,724      462,585    20.4     17.3  
                         

Total services revenue

   $ 828,879    $ 688,296    $ 596,956    20.4 %   15.3 %
                         

Consulting and education revenues consist of professional services related to the deployment and use of our software products. These arrangements are generally structured on a time and materials basis and revenues are recognized as services are performed. Customer support and maintenance revenues consist of fees for annual maintenance contracts, typically priced as a percentage of the license fee, and recognized ratably over the term of the agreement (generally one year). Total services revenues for fiscal 2007 were positively impacted by a fluctuation in exchange rates, whereas total services revenue for fiscal 2006 were not significantly impact by a fluctuation in exchange rates. Total services revenues for fiscal 2007, when translated at a constant exchange rate from the same period in the prior year, would have been $823.3 million, an increase of 19.6 percent over the same period in fiscal 2006 versus an absolute increase of 20.4 percent.

The $110.5 million and $80.1 million increase in customer support and maintenance revenues for fiscal 2007 and fiscal 2006 was driven primarily by maintenance renewals on our existing installed base of software licenses, including in fiscal 2007 the Plumtree installed base renewals that were acquired, as well as maintenance contracts sold together with new sales of software licenses.

 

67


Table of Contents

The increase in consulting and education revenues for fiscal 2007 compared to fiscal 2006 was due to a 25.4 percent increase in consulting services primarily related to providing services associated with products acquired from Plumtree and Fuego. The 8.3 percent increase in consulting and education revenues in fiscal 2006 compared to fiscal 2005 was primarily due to an increase in consulting services performed in the Americas. Management believes this increase was due to incremental revenues generated by providing services associated with products acquired from Plumtree subsequent to the acquisition in October 2005, increased demand around solutions frameworks and the introduction of new consulting programs into our enterprise accounts.

Revenues by Geographic Region

The following tables provide a summary of revenues by geographic region (in thousands):

 

     Fiscal 2007    Fiscal 2007
(percentage of
consolidated
total
revenues)
    Fiscal 2006    Fiscal 2006
(percentage of
consolidated
total
revenues)
    Fiscal 2005    Fiscal 2005
(percentage of
consolidated
total
revenues)
 

Americas

   $ 752,082    53.6 %   $ 622,624    51.9 %   $ 536,564    49.7 %

EMEA

     446,464    31.8       397,815    33.1       383,328    35.5  

APAC

     203,803    14.6       179,406    15.0       160,202    14.8  
                                       

Total revenues

   $ 1,402,349    100.0 %   $ 1,199,845    100.0 %   $ 1,080,094    100.0 %
                                       

For each of the twelve fiscal quarters included in the three fiscal years ended January 31, 2007, international revenues as a percentage of total revenues have ranged between 31 percent to 38 percent for EMEA and 14 percent to 16 percent for APAC. These ranges are expected to continue to fluctuate in the future depending upon regional economic conditions, foreign currency exchange rates, and other factors.

In fiscal 2007, the percentage of total revenue contribution from the Americas increased to 53.6 percent from 51.9 percent when compared to the prior year. The Americas revenue contribution was positively impacted by the Plumtree acquisition since the revenues from the products acquired were generated primarily in the United States. The increase in the Americas revenue for fiscal 2007 compared to fiscal 2006 was comprised of a 14.9 percent increase in license revenue and a 25.1 percent increase in services revenue. The increase in Americas services revenue was due to increases in customer support and maintenance revenues and consulting and education revenues of 22.4 percent and 34.4 percent, respectively. In fiscal 2006, the percentage of total revenue contribution from the Americas increased to 51.9 percent from 49.7 percent when compared to the prior year. The increase in the Americas revenue for fiscal 2006 compared to fiscal 2005 was comprised of a 12.1 percent increase in license revenue and a 19.0 percent increase in services revenue. The increase in Americas services revenue was due to increases in customer support and maintenance revenues and consulting and education revenues of 20.1 percent and 15.3 percent, respectively.

In fiscal 2007, the percentage of total revenue contribution from EMEA declined to 31.8 percent from 33.1 percent when compared to the prior year. The percentage decline in EMEA’s contribution was primarily impacted by the products acquired from Plumtree whose revenues were generated in the United States. EMEA’s revenues increased by $48.6 million from fiscal 2006 to fiscal 2007 due to growth in license revenues of 11.5 percent and growth in the services business of 12.7 percent. Customer support and maintenance revenues increased 15.9 percent year over year across the region. Consulting and education increased slightly for the region; however there was one country where it declined significantly due to a non-recurring project recognized in fiscal 2006. Our revenues in EMEA in fiscal 2007 were positively impacted by a fluctuation in exchange rates. Total EMEA revenues for fiscal 2007, when translated at a constant exchange rate from the same period in the prior year, would have been $436.9 million, an increase of 9.8 percent over the same period in fiscal 2006 versus an absolute increase of 12.2 percent.

 

68


Table of Contents

In fiscal 2006, the percentage of total revenue contribution from EMEA declined to 33.1 percent from 35.5 percent due to slower total revenue growth when compared to the other regions year over year. The increase in total EMEA revenues in absolute dollars for fiscal 2006 compared to fiscal 2005 was due to growth in the services business of 9.7 percent offset by a slight decline in license revenue of 4.1 percent. France, Germany, Finland and Spain had strong license and services growth in fiscal 2006 compared to fiscal 2005. The increase in services revenue in 2006 was due to a 13.9 percent increase in the customer support and maintenance revenues across EMEA. The decline in license revenues in 2006 was due primarily to an unfavorable foreign exchange rate impact and a very strong prior year of license sales. Our revenues in EMEA in fiscal 2006 were negatively impacted by the weakening of certain foreign currencies against the U.S. dollar, particularly the Euro and the British Pound. Total EMEA revenues for fiscal 2006, when translated at a constant exchange rate from the same period in the prior year, would have been $402.2 million, an increase of 4.9 percent over the same period in fiscal 2005 versus an absolute increase of 3.8 percent.

In fiscal 2007, the percentage of total revenue contribution from APAC declined to 14.6 percent from 15.0 percent when compared to the prior year. The percentage decline in APAC’s revenue contribution was primarily impacted by the products acquired from Plumtree whose revenues were generated in the United States. APAC’s revenues increased by $24.4 million when comparing fiscal 2007 to fiscal 2006 and the increase was due to growth in all revenue streams. License revenues increased 5.4 percent and services revenue increased 22.6 percent, which also included a 23.7 percent increase in the customer support and maintenance revenues across the region. Total revenues increased in all countries with the exception of Japan, which declined 6.7 percent. Our revenues in APAC in fiscal 2007 were negatively impacted by a fluctuation in exchange rates mostly due to the Japanese yen. Total APAC revenues for fiscal 2007, when translated at a constant exchange rate from the same period in the prior year, would have been $206.4 million, a increase of 15.1 percent over the same period in fiscal 2006 versus an absolute increase of 13.6 percent.

In fiscal 2006, the percentage of total revenue contribution from APAC increased slightly to 15.0 percent from 14.8 percent when compared to the prior year. The increase in total APAC revenues for fiscal 2006 compared to fiscal 2005 was due to growth in all revenue streams and across the region. License revenues increased 8.1 percent and services revenue increased 16.6 percent, which also included a 15.9 percent increase in the customer support and maintenance revenues across the region. APAC revenues were not significantly impacted by exchange rates in fiscal 2006.

Deferred revenue and backlog

The following table sets forth the components of deferred revenue (in thousands):

 

     January 31
     2007    2006

License fees

   $ 13,797    $ 16,133

Services

     435,485      362,990
             

Total deferred revenue

   $ 449,282    $ 379,123
             

Management does not believe that backlog, as of any particular date, is a reliable indicator of future performance. The concept of backlog is not defined in the accounting literature, making comparisons with other companies difficult and potentially misleading. BEA typically receives and fulfills most of the orders within the quarter and a substantial portion of the orders, particularly the larger transactions, are usually received in the last month of each fiscal quarter, with a concentration of such orders in the final week of the quarter. Although it is generally our practice to promptly ship product upon receipt of properly finalized purchase orders, BEA frequently has license orders that have not shipped or have otherwise not met all the required criteria for revenue recognition. In some of these cases, BEA exercises discretion over the timing of product shipments, which affects the timing of revenue recognition for software license orders. In those cases, BEA considers a number of factors, including: the effect of the related license revenue on our business plan; the delivery dates requested by

 

69


Table of Contents

customers and resellers; the amount of software license orders received in the quarter; the amount of software license orders shipped in the quarter; the degree to which software license orders received are concentrated at the end of the quarter; and our operational capacity to fulfill software license orders at the end of the quarter. Although the amount of such license orders may vary, management generally does not believe that the amount, if any, of such license product orders at the end of a particular quarter is a reliable indicator of future performance because, as noted above, such a large portion of the revenue is concentrated at the end of the quarter.

Deferred revenue, as of January 31, 2007, was comprised of (1) unexpired customer support contracts of $412 million, (2) undelivered consulting and education orders of $23 million and (3) license orders that have shipped but have not met revenue recognition requirements of $14 million. Off balance sheet backlog was comprised of services orders received and not delivered of $41 million and license orders received but not shipped of $10 million. At January 31, 2007, our aggregate backlog (deferred revenue and off balance sheet backlog) was $500 million of which $449 million is included on our balance sheet as deferred revenue.

Deferred revenue, as of January 31, 2006, was comprised of (1) unexpired customer support contracts of $341 million, (2) undelivered consulting and education orders of $22 million and (3) license orders that have shipped but have not met revenue recognition requirements of $16 million. Off balance sheet backlog was comprised of services orders received and not delivered of $35 million and license orders received but not shipped of $31 million. At January 31, 2006, our aggregate backlog (deferred revenue and off balance sheet backlog) was $445 million of which $379 million is included on our balance sheet as deferred revenue.

Cost of Revenues

The following table provides a summary of cost of revenues (in thousands):

 

     Fiscal 2007    Fiscal 2006
As Restated(1)
   Fiscal 2005
As Restated(1)
   Percentage
change
fiscal 2007
vs. fiscal 2006
    Percentage
change
fiscal 2006
vs. fiscal 2005
 

Cost of license fees

   $ 64,221    $ 38,778    $ 34,302    65.6 %   13.0 %

Cost of services

     269,105      218,434      190,571    23.2     14.6  
                         

Total cost of revenues

   $ 333,326    $ 257,212    $ 224,873    29.6 %   14.4 %
                         

(1) See the “Explanatory Note” immediately preceding Part I, Item 1 and Note 2, “Restatement of Consolidated Financial Statements,” in Notes to Consolidated Financial Statements of this Form 10-K.

Cost of License Fees. Cost of license fees, as referenced in the table above, includes:

 

   

the amortization of certain acquired intangible assets including amortization of purchased technology, non-compete agreements, customer base, patents, trademarks and distribution rights;

 

   

direct costs and fees paid to third-party contractors in connection with our customer license compliance program;

 

   

royalties and license fees paid to third parties based on a per copy fee or a prepaid fee amortized straight-line over the contractual period; and

 

   

costs associated with transferring our software to electronic media; the printing of user manuals; and packaging, distribution and localization costs.

Cost of license fees were 11.2 percent, 7.6 percent and 7.1 percent of license revenues for fiscal 2007, 2006 and 2005, respectively. The increase in the cost of license fees as a percentage of license revenues for fiscal 2007 compared to fiscal 2006 was due primarily to an increase in amortization expense related to acquired intangibles of approximately $24.3 million. The increase in amortization expense resulted from the completion of five acquisitions in the second half of fiscal 2006 and early fiscal 2007. Management believes that cost of license fees

 

70


Table of Contents

may continue to increase in absolute dollars in fiscal 2008 due to expansion of the customer license compliance program as well as royalty expenses associated with our new product lines and the respective mix of products sold quarterly.

The decline in the cost of license fees as a percentage of license revenues for fiscal 2006 compared to fiscal 2005 was due to the increase in license revenues offset by a slight increase in expenses. Amortization of intangibles and compliance costs increased slightly offset by small declines in third party royalties and distribution costs.

Amortization expense of $38.4 million was recorded for fiscal 2007 associated with intangible assets recorded prior to January 31, 2007 and future amortization expense over each of the next five years is currently expected to total approximately $29.9 million, $16.7 million, $12.0 million, $7.6 million and $1.8 million annually. The increase in future amortization expense in fiscal 2007 as compared to fiscal 2006 is mainly due to the amortization of the Plumtree, Fuego and Flashline acquired intangibles. We periodically review the estimated remaining useful lives of our intangible assets. A reduction in our estimate of remaining useful lives, if any, could result in increased amortization expense in future periods.

Cost of Services. Cost of services, consists primarily of salaries and benefits for consulting, education, and product support personnel; cost of third party delivered education and consulting revenues; and infrastructure expenses in information technology and facilities for the operation of the services organization. Cost of services was 32.5 percent of services revenues in fiscal 2007 compared to 31.7 percent of services revenues in fiscal 2006. The 0.8 percent increase in cost of services as a percent of services revenues was primarily due to share-based compensation expense associated with the implementation of FAS123R and an increase in amortization expense related to acquired intangibles. The increase were offset by improved margins associated with the acquired services business of Plumtree and Fuego. Total headcount at the end of the period increased 62 people year over year.

Cost of services in fiscal 2007 were impacted by a fluctuation in exchange rates. Total cost of services for fiscal 2007, when translated at a constant exchange rate from the same period in the prior year, would have been $263.1 million, an increase of 20.8 percent over the same period in fiscal 2006 versus an absolute increase of 23.2 percent.

Cost of services was 31.7 percent of services revenues in fiscal 2006 compared to 31.9 percent of services revenues in fiscal 2005. The 0.2 percent decline in cost of services as a percent of services revenues was primarily due to services expenses increasing at a slower rate than the increase in services revenues (primarily customer support and maintenance revenues. There was a larger mix of higher margin customer support and maintenance revenues versus lower margin consulting and education revenues. Total cost of services in fiscal 2006 was not materially impacted by a fluctuation in exchange rates. Total headcount at the end of the period increased 130 people year over year.

Operating Expenses

Sales and Marketing (in thousands):

 

     Fiscal 2007   

Fiscal 2006

As Restated(1)

  

Fiscal 2005

As Restated(1)

  

Percentage
change
fiscal 2007
vs.

fiscal 2006

   

Percentage
change
fiscal 2006
vs.

fiscal 2005

 

Sales and marketing expenses

   $ 524,970    $ 437,769    $ 398,676    19.9 %   9.8 %

(1) See the “Explanatory Note” immediately preceding Part I, Item 1 and Note 2, “Restatement of Consolidated Financial Statements,” in Notes to Consolidated Financial Statements of this Form 10-K.

 

71


Table of Contents

Sales and marketing expenses include salaries, benefits, sales commissions, travel, certain information technology and facility costs for our sales and marketing personnel. These expenses also include programs aimed at increasing revenues, such as advertising, public relations, trade shows and user conferences. The increase in expenses from fiscal 2007 compared to fiscal 2006 was primarily due to compensation-related expenses. Compensation-related expenses increased $56.8 million due to (1) an increase of 40.6 million for salary and benefits related to an increase of 154 headcount (2) an increase of $18.3 million in share based compensation related to the implementation of FAS123R and (3) a reduction in incremental share-based compensation related to modifications and employment taxes of $2.0 million.

Sales and marketing expenses were adversely impacted by foreign exchange rates. In the fiscal year ended January 31, 2007, sales and marketing expenses of $525.0 million when translated at constant exchange rates from the same period in the prior year would have been approximately $520.0 million, which is a 18.8 percent increase over costs of services of $437.8 million for the same period in the prior year.

The increase in sales and marketing expenses from fiscal 2005 to fiscal 2006 was primarily due to compensation-related expenses including an increase in variable compensation as well as sales and marketing headcount. Sales and marketing variable compensation increased by approximately $17.9 million and fixed compensation increased $10.9 million. Variable compensation increased consistently with the increase in revenues and fixed compensation increased due to average salary increases and the increase in headcount of approximately 130 from fiscal 2005 to fiscal 2006. Foreign currency did not have a significant impact on fiscal 2006 results.

Research and Development (in thousands):

 

     Fiscal 2007    Fiscal 2006
As Restated(1)
   Fiscal 2005
As Restated(1)
  

Percentage
change
fiscal 2007
vs.

fiscal 2006

   

Percentage
change
fiscal 2006
vs.

fiscal 2005

 

Research and development expenses

   $ 232,960    $ 182,234    $ 146,850    27.8 %   24.1 %

(1) See the “Explanatory Note” immediately preceding Part I, Item 1 and Note 2, “Restatement of Consolidated Financial Statements,” in Notes to Consolidated Financial Statements of this Form 10-K.

Research and development expenses consist primarily of salaries and benefits for software engineers, contract development fees, costs of computer equipment used in software development, certain information technology and facilities expenses. All costs incurred in the research and development of software products and enhancements to existing products have been expensed as incurred. Research and development expenses as a percentage of total revenues increased to 16.6 percent in fiscal 2007 from 15.2 percent and 13.6 percent for fiscal 2006 and fiscal 2005. The increase as a percentage of total revenues for fiscal 2007 compared to fiscal 2006 was due in part to the integration of acquisitions completed in the second half of fiscal 2006 and the related full year of expenses, a decline in third party funding associated with product development agreements and continued investment in research and development, specifically related to the international telecommunications technology centers.

The increase in research and development expenses as a percent of total revenue in fiscal 2006 compared to fiscal 2005 was due to BEA’s concerted effort to invest in research and development, which included new product releases, new products (WebLogic Communications Platform and the AquaLogic product family) as well as six acquisitions of technology companies in the prior 15 months.

Research and development expenses increased by $50.7 million in fiscal 2007 as compared to fiscal 2006. This increase was driven by both organic new product development as well as acquired product development teams from 6 acquisitions over the past 18 months ( M7, ConnecTerra, Plumtree, SolarMetric, Fuego and

 

72


Table of Contents

Flashline). As of January 31, 2007, research and development was comprised of 1,248 employees, 175 of whom were obtained through the 6 acquisitions during the course of the fiscal 2006 and fiscal 2007. Of the 1,248 employees, 790 were located in the United States and 458 were located outside of the United States. The $50.7 million increase in research and development expenses in fiscal 2007 compared to fiscal 2006 was primarily composed of (1) salary and benefits expense of $21.0 million related to the increase of 170 people (through acquisition and organic growth), (2) share-based compensation expense associated with the implementation of FAS123R of $14.0 million and (3) acquisition related deferred compensation of $3.3 million and (4) a reduction of $5.3 million of third party funding related to development agreements, which offsets research and development expense on a quarterly basis as discussed below. Research and development expenses were not significantly impacted by foreign exchange rates in fiscal 2007.

Research and development expenses increased $35.4 million in fiscal 2006 as compared to fiscal 2005. This increase was driven by both organic new product development as well as acquired product development teams from 4 acquisitions (M7, ConnecTerra, Plumtree and Solarmetric) completed in the second half of fiscal 2006 and a full year of impact of the one acquisition (Incomit AB) completed in late fiscal 2005. As of January 31, 2006, research and development was comprised of 1,078 employees, 150 of whom were obtained through the 4 acquisitions during the course of the fiscal 2006. Of the 1,078 employees, 796 were located in the Americas region and 282 were located outside of the Americas region. The $35.4 million increase in research and development expenses in fiscal 2007 was primarily composed of (1) $16.8 million increase in compensation expense from an additional 90 organically-hired employees, as well as annual merit increases and variable compensation for the entire employee base; and (2) $8.7 million increase in headcount and non-headcount expenses obtained through acquisition, the majority of which was $7.3 million related to Plumtree’s operations.

We have entered into product development agreements with third parties to develop ports and integration tools, for which the third parties provide expense reimbursement. In addition, we have one significant product development arrangement with a third party to co-develop a product of mutual interest, for which the third party has historically provided expense reimbursement for certain product development and marketing expenses. Historically, the funding received from these arrangements was intended to offset certain research and development and marketing costs and was non-refundable, and such amounts were recorded as a reduction in our operating expenses. In fiscal 2007, we received $4.4 million of third party reimbursement, $1.6 million of which related to the development of ports and integration tools and $2.8 million related to product development expenses. We did not receive funding for the product of mutual interest in the first and second quarter of fiscal 2007 as the arrangement was not finalized. We did receive approximately $1.4 million in the third and fourth quarter. In fiscal 2006, we received $10.3 million of third party reimbursement, of which $1.6 million related to the development of ports and integration tools, $8.1 million related to product development expenses and $0.6 million related to certain marketing expenses. During fiscal 2005, we received a total of $10.5 of third party reimbursements, $0.9 million of which was related to the development of ports and integration tools, $8.6 million of which was related to certain product development expenses and $1.0 million of which was related to certain marketing expenses of the product of mutual interest. For fiscal 2008, the product development arrangement with the third party to co-develop the product of mutual interest was finalized and we expect to receive approximately $0.8 million to $1.0 million based on delivery of pre-defined deliverables.

General and Administrative (in thousands):

 

     Fiscal 2007    Fiscal 2006
As Restated(1)
   Fiscal 2005
As Restated(1)
  

Percentage
change
fiscal 2007
vs.

fiscal 2006

   

Percentage
change
fiscal 2006
vs.

fiscal 2005

 

General and administrative expenses

   $ 138,255    $ 108,660    $ 95,999    27.2 %   13.2 %

(1) See the “Explanatory Note” immediately preceding Part I, Item 1 and Note 2, “Restatement of Consolidated Financial Statements,” in Notes to Consolidated Financial Statements of this Form 10-K.

 

73


Table of Contents

General and administrative expenses increased $29.6 million for fiscal 2007 compared to fiscal 2006 due to $13.7 million of share-based compensation expense associated with the implementation of FAS123R, $2.8 million of acquisition-related deferred compensation, $9.5 million in labor expenses due in part to the Plumtree and Fuego acquisitions, $6.8 million of expenses associated with the Company’s internal stock option review (i.e., legal, consulting and stock option modification expenses) and offset by a $4.5 million decline in legal expenses related to intellectual property litigation. General and administrative expenses were not significantly impacted by foreign exchange rates in the first nine months of fiscal 2007.

General and administrative expenses increased $12.7 million in fiscal 2006 from fiscal 2005 due primarily to $11.7 million of compensation related expenses and the remainder was due to purchased services. The $11.7 million of compensation expense was comprised of $5.0 million related to average salary increases, an increase in headcount and related personnel expenses, and $6.7 million related to fiscal 2006 variable compensation. Purchased services increased by $1.9 million related to certain tax matters and initiatives and $1.8 million related to legal expenses primarily pertaining to litigation matters offset by a $1.0 million decline in third party accounting expenses related to the compliance with the regulations of the Sarbanes-Oxley Act of 2002.

Other Charges

Facilities Consolidation. During fiscal 2002, we approved a plan to consolidate certain facilities in regions including the United States, Canada and Germany. A facilities consolidation charge of $20.0 million was recorded using management’s best estimates and was based upon the remaining future lease commitments and brokerage fees for vacant facilities from the date of facility consolidation, net of estimated future sublease income. In fiscal 2005, fiscal 2006 and fiscal 2007, an additional $0.5 million, $0.8 million and $0.5 million was accrued due to a reassessment of original estimates of costs of abandoning the leased facilities compared to the actual results and future estimates.

During fiscal 2005, due to a decline in employee and contractor hiring and headcount we identified the opportunity to reduce our facilities requirements. We approved a plan to consolidate six sites in the United States and Canada. A facilities consolidation charge of $7.7 million was recorded and was comprised of $6.9 million related to future lease commitments and $0.8 million of leasehold improvement write-offs. The $6.9 million of future lease commitments was calculated based on management’s estimates and the present value of the remaining future lease commitments for vacant facilities, net of present value of the estimated future sublease income.

The estimated costs of abandoning the leased facilities identified above, including estimated costs to sublease, were based on market information and trend analyses, including information obtained from third-party real estate industry sources. As of January 31, 2007, $8.1 million of lease termination costs, net of anticipated sublease income, remains accrued and is expected to be fully utilized by fiscal 2012. As of January 31, 2007, $2.3 million is classified as short term and the remaining $5.0 million is classified in other long term obligations. As of January 31, 2006, $2.3 million is classified as short term and the remaining $7.4 million is classified in other long term obligations. If actual circumstances prove to be materially different than the amounts management has estimated, our total charges for these vacant facilities could be significantly higher. If we were unable to receive any of our estimated but uncommitted sublease income in the future, the additional charge would be approximately $2.4 million. Adjustments to the facilities consolidation charge will be made in future periods, if necessary, based upon then current actual events and circumstances.

We do not expect the future payments to have a significant impact on our liquidity due to our strong cash position ($1.2 billion of cash, cash equivalents and short term investments at January 31, 2007).

 

74


Table of Contents

The following table provides a summary of the accrued facilities consolidation (in thousands):

 

     Facilities
consolidation
 

Accrued at January 31, 2005

   $ 12,232  

Additional charges accrued during fiscal 2006 included in operating expenses

     807  

Cash payments during fiscal 2006

     (3,358 )
        

Accrued at January 31, 2006

     9,681  

Additional charges accrued during fiscal 2007 included in operating expenses

     454  

Cash payments during fiscal 2007

     (2,011 )
        

Accrued at January 31, 2007

   $ 8,124  
        

Acquisition-related in-process research and development. In-process research and development (“IPR&D”) represents incomplete research and development projects that had not reached technological feasibility and had no alternative future use at the date the assessment was made in conjunction with the acquisition and consequently was written off in the fiscal year ended January 31, 2006 and 2007. The value assigned to IPR&D was determined by considering the importance of the project to the overall development plan, estimating cost to develop the acquisition related IPR&D into commercially viable products, estimating the resulting net cash flows from the project when completed and discounting the net cash flows to their present value based on the percentage of completion of the IPR&D project.

Impairment of Land. As of January 31, 2007, we determined that there was a more likely than not chance that the San Jose Land would be disposed of within the next 12 months. We completed an impairment review in accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, and we concluded that a $201.6 million write-down of the San Jose Land was required, reducing the value of that land to a new carrying value of $105.0 million. The San Jose Land was subsequently sold in the first quarter of fiscal 2008 for $106.0 million, net of transaction costs.

Office Lease. On August 14, 2006, the Company entered into a new office lease in San Francisco to enable consolidation of the three current San Francisco office locations, including two acquired with the acquisition of Plumtree Software, Inc. in October 2005. The new office lease commenced on August 14, 2006 and terminates on December 31, 2016. The office space under this new lease will undergo renovations for approximately six months. During the renovation period, the Company is recording rent expense for both the new and existing office space, which resulted in an increase in operating expenses of approximately $1.5 million in the third quarter of fiscal 2007 and $1.5 million in the fourth quarter of fiscal 2007, and will result in an increase of $1.4 million in the first quarter of fiscal 2008.

In the second quarter of fiscal 2008, the Company occupied new office space and vacated the three existing San Francisco office locations. Two of the three existing office leases expire in fiscal 2008 and the remaining one expires in fiscal 2009. In the second quarter of fiscal 2008, the Company incurred a facilities consolidation charge of $2.5 million.

 

75


Table of Contents

Interest and Other, Net

The following table provides a summary of the items included in interest and other, net (in thousands):

 

     Fiscal 2007     Fiscal 2006     Fiscal 2005    

Percentage
change
fiscal 2007
vs.

fiscal 2006

   

Percentage
change
fiscal 2006
vs.

fiscal 2005

 

Interest expense

   $ (22,623 )   $ (32,072 )   $ (29,984 )   (29.5 )%   7.0 %

Gain on retirement of convertible subordinated notes

     818       667       —       22.6     100.0  

Net gains (losses) on sale of equity investments

     11,074       —         —       N/M     N/M  

Foreign exchange loss

     (171 )     (1,449 )     (1,054 )   (88.2 )   37.5  

Interest income and other, net

     55,219       42,443       23,392     30.1     81.4  
                                    

Total interest and other, net

   $ 44,317     $ 9,589     $ (7,646 )   N/M %   N/M %
                                    

Note: “N/M” is defined as “not meaningful”.

Interest expense is a function of outstanding balance of our convertible debt and the $215.0 million of notes payable. The decline in interest expense for fiscal 2007 compared to fiscal 2006 correlates with the repurchase of approximately $295 million in face value of convertible subordinated notes in the fourth quarter of fiscal 2006 and the first quarter of fiscal 2007 as well as the full payoff of the convertible notes in December 2006. The reduction of interest expense was partially offset by the increase in the interest rates related to notes payable. Interest expense increased in fiscal 2006 from fiscal 2005 due to interest rates rising on the outstanding notes payable offset by a slight decline in interest expense related to the convertible debt due to the retirement of $84.8 million of the face value of the convertible debt.

Interest income and other, net increased $14.8 million for fiscal 2007 compared to fiscal 2006. The increase for fiscal 2007 was primarily due to improved yields on our cash, cash equivalents and short-term investment balances. The increase in interest income and other, net, from fiscal 2005 to fiscal 2006 of $16.9 million was due to improved yields and the average increase in our cash, cash equivalents and short-term investment balances throughout the year.

In addition in fiscal 2007, we recorded net gains on the disposition of minority interests in strategic equity investments of approximately $11.0 million, a net gain on the retirement of the convertible subordinated notes of $0.8 million and a write-off of debt issuance costs of approximately $0.8 million. In addition in fiscal 2006, we recorded $2.0 million in non-operating gains related to two minority interest investments in equity securities that had been written off due to impairment in a previous fiscal year and sold during fiscal 2006. There was $0.2 million in write-downs of equity investments during fiscal 2005.

Foreign exchange gain (loss) fluctuates as a result of changes in foreign currency denominated monetary assets and liabilities net of changes in foreign exchange forward hedge contracts.

Provision for Income Taxes

We have provided for income tax expense of $6.2 million, $75.0 million and $52.2 million for fiscal 2007, 2006 and 2005, respectively. Our effective income tax rates were 57.9, 34.4 and 26.4 percent for fiscal 2007, 2006 and 2005, respectively. Our effective income tax rate for fiscal 2007 differed from the U.S. federal statutory rate of 35 percent primarily due to the tax impact of FAS 123R, the impact of non-deductible in-process research and development related to the Fuego and Flashline acquisitions, and an increase in the valuation allowance, partially offset by benefits of lower taxed foreign earnings. Our effective income tax rate for fiscal 2006 differed from the U.S. federal statutory rate primarily due to the benefits of lower taxed foreign earnings and valuation allowance, partially offset by the expense of the distribution under the Jobs Act. Our effective tax rate for fiscal

 

76


Table of Contents

2005 differed from the U.S. federal statutory rate primarily due to the benefit of low taxed foreign earnings, and benefits from the resolution of certain tax audits and the lapse of the statutes of limitations with respect to certain federal and foreign tax years.

The Provision for income taxes presented for 2006 and 2005 has been increased by approximately $2.3 million for 2006 and decreased by approximately $4.0 million for 2005, due to the tax effect of the restatement for stock compensation charges. See Note 2, “Restatement of Consolidated Financial Statements,” in Notes to Consolidated Financial Statements of this Form 10-K for additional details.

Under Statement of Financial Accounting Standards No. 109 Accounting for Income Taxes (“FAS 109”), deferred tax assets and liabilities are determined based on the difference between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. FAS 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. As a result of recent U.S. operating results, as well as U.S. jurisdictional forecasts of taxable income, we believe that net deferred tax assets in the amount of $218.0 million are realizable based on the “more likely than not” standard required for recognition. Accordingly, during fiscal 2007 we reduced the valuation allowance to recognize such net deferred assets. We intend to continue to evaluate the realizability of the deferred tax assets on a quarterly basis.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FAS 109, Accounting for Income Taxes” (“FIN 48”), to create a single model to address accounting for uncertainty of tax positions. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting for interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We adopted FIN 48 as of February 1, 2007, as required. The cumulative effect of adopting FIN 48 will be recorded in retained earnings. We expect to have the following impact on our financial position and results of operations. Upon initial adoption, the expected cumulative effect of applying the provisions of FIN 48 is an increase in tax liabilities of $10 million. This will be reported as an adjustment to the opening balance of retained earnings. There may be an affect to the effective income tax rate in future years along with greater volatility due to the adoption of FIN 48.

Liquidity and Capital Resources

Cash flows

Our primary sources of cash are receipts from our revenues and customer support contract billings. A secondary source of cash is proceeds from the exercise of employee stock options. The primary uses of cash for operating purposes are payroll (salaries, bonuses, commissions and benefits) and general expenses (facilities, marketing, legal, travel, etc.). The secondary uses of cash are our stock repurchase program and the retirement of our convertible subordinated notes.

Net cash provided by operating activities was $204.4 million and $284.6 million for the years ended January 31, 2007 and 2006, respectively. The cash provided by operating activities was due to our net income adjusted by:

 

   

Non-cash charges of $222.3 million and $76.7 million for the years ended January 31, 2007 and 2006, respectively, primarily related to land impairment charges, the reclassification of excess tax benefits from exercise of stock options, stock based compensation and stock option modification expense, acquired intangibles amortization, deferred compensation amortization, depreciation, accretion on investment balances, and in-process research and development.

 

   

Non-cash charges for the year ended January 31, 2007 included $201.6 million of land impairment charges associated with the 40 acres of land located adjacent to our current headquarters in San Jose, CA., $61.7 million of depreciation and acquired intangible amortization expense, $59.0

 

77


Table of Contents
 

million of stock based compensation and stock option modification expense, $9.4 million of deferred compensation amortization, and $4.4 million of write-offs of in-process research and development costs. Offsets included a reclassification to financing activities of $106.0 million from the cumulative excess tax benefits associated with stock option deductions in accordance with the implementation of FAS 123R and gains of $11.1 million related to sales of minority interest in equity investments. The reclassification of $106.0 million of excess tax benefits from stock option deductions was primarily the result of releasing valuation allowances on related deferred tax assets in the fourth quarter of fiscal 2007.

 

   

Non-cash charges for the year ended January 31, 2006 primarily included $38.1 million of depreciation and amortization expense, $20.7 million of stock based compensation expense, and $4.6 million of write-offs of in-process research and development costs. Offsets included $4.1 million of accumulated accretion on investment balances.

 

   

Changes in operating assets and liabilities resulted in a net decrease of $22.5 million and a net increase of $64.7 million for the year ended January 31, 2007 and 2006, respectively, which were generated in the normal course of business. These changes are highlighted as follows:

 

   

Net cash decreases during the year ended January 31, 2007 are primarily attributable to increases in deferred revenues of $68.0 million, increases in accounts payable and accrued liabilities of $47.8 million and a decrease in other current assets of $4.2 million. These were partially offset by increases in accounts receivable of $59.7 million, increases in deferred tax assets of $65.8 million, and a $16.9 million change in other working capital components (principally the non-cash effects of exchange rates on other working capital items).

 

   

Net cash increases during the year ended January 31, 2006 from changes in account balances was primarily attributable to increases in deferred revenues of $55.5 million, increases in accounts payable and accrued liabilities of $103.5 million. These were partially offset by increases in accounts receivable of $54.1 million and increases in other current and long-term assets of $47.4 million, due primarily to the increase in long-term deferred tax assets recorded in fiscal 2006.

Investing Activities

Net cash provided by (used in) investing activities for the year ended January 31, 2007 and 2006 was ($115.1) million and $191.5 million, respectively. Investing activities included purchases, sales and maturities of available-for-sale securities, capital expenditures, proceeds from the sale of minority equity investments, changes in restricted cash requirements and acquisitions.

 

   

Net cash used in investing activities for the year ended January 31, 2007 was primarily comprised of $129.9 million of cash used in payments for acquisitions, net of cash acquired and $26.4 million used in capital expenditures and proceeds from maturities and sales of available-for-sale investments of $570.9 million, partially offset by purchases of available-for-sale investments of $541.3 million.

 

   

Net cash used in investing activities for the year ended January 31, 2006 was primarily comprised of $211.5 million of cash used in payments for acquisitions, net of cash acquired and $20.7 million used in capital expenditures and proceeds from maturities and sales of available-for-sale investments of $964.1 million, partially offset by purchases of available-for-sale investments of $542.4 million.

Financing Activities

Net cash used in financing activities for the year ended January 31, 2007 and 2006 was $263.1 million and $216.9 million, respectively. Financing activities included repurchases and retirement of the short-term convertible subordinated notes, excess tax benefits from stock-based payment arrangements, net proceeds received for employee stock purchases, and purchases of treasury stock.

 

   

Net cash used in financing activities for the year ended January 31, 2007 was primarily comprised of the repurchase and retirement of our short-term convertible subordinated notes of $463.8 million,

 

78


Table of Contents
 

partially offset by $94.7 million in net proceeds from employee stock purchases and $106.0 million in cumulative excess tax benefits from exercise of stock options that were reclassified as a financing activity from an operating activity under FAS 123R, which resulted from the release of valuation allowances on related deferred tax assets in the fourth quarter of fiscal 2007.

 

   

Net cash used in financing activities for the year ended January 31, 2006 was primarily comprised of treasury stock repurchases of $193.7 million and repurchase of convertible subordinated notes $83.8 million, partially offset by $60.5 million in net proceeds received for employee stock purchases.

Liquidity

Our principal source of liquidity is our cash, cash equivalents and short and long-term investments, as well as the cash flow that we generate from our operations. Our liquidity could be negatively impacted by any trends that result in a reduction in demand for our products or services. We believe that our existing cash, cash equivalents, short and long-term investments and cash generated from operations, if any, will be sufficient to satisfy our currently anticipated cash requirements through January 31, 2008. However, we may make acquisitions or license products and technologies complementary to our business and may need to raise additional capital through future debt or equity financing to the extent necessary to fund any such acquisitions or licenses. There can be no assurance that additional financing will be available, at all, or on terms favorable to us.

 

     Fiscal 2007    Fiscal 2006   

Percentage
change
fiscal 2007
vs.

fiscal 2006

 

Cash and cash equivalents

   $ 867,294    $ 1,017,772    (14.8 )%

Short term investments

     313,941      370,763    (15.3 )

Long term investments

     93,528      64,422    45.2  
                    

Total cash, cash equivalents and investments

     1,274,763      1,452,957    (12.3 )
                

Convertible subordinated notes

     —        465,250    (100.0 )
                

Credit Facility or long term debt facility

   $ 215,000    $ 215,000    0 %
                

Contractual Obligations

On July 31, 2006, the Company entered into a five-year $500.0 million unsecured revolving credit facility (the “Credit Facility”). At closing, the Company borrowed $215.0 to repay in full and terminate the long term debt facility which was scheduled to mature in October 2008. The Credit Facility permits prepayment of outstanding loans at any time without premium or penalty. On June 29, 2007, subsequent to year-end, the Company repaid the entire $215 million outstanding balance under the credit facility, and the Credit Facility remains in effect.

Loans under the Credit Facility accrue interest at the election of the company at the prime rate or the London Interbank Offering Rate (“LIBOR”) plus a margin based on our leverage ratio, determined quarterly. The effective annual interest rate was approximately 5.8 percent as of January 31, 2007. Interest payments are made in cash at intervals ranging from one to three months, as elected by the Company. Principal, together with accrued interest, is due on the maturity date of July 31, 2011.

The Credit Facility requires the Company to comply with interest, leverage and liquidity covenants. It contains other standard affirmative and negative covenants and conditions of default. On September 11, 2006, the Company provided notice to the Administrative Agent and the lenders party to the Credit Facility that a default had occurred because the Company had not timely furnished certified financial statements. On October 6, 2006 and December 8, 2006, the Company was granted Waiver No. 1 and Waiver No. 2 that waived compliance by the Company with the requirements of the Credit Facility to deliver the financial statements and the compliance

 

79


Table of Contents

certificates for the quarters ended July 31, 2006 and October 31, 2006, respectively. Waiver No. 2 was granted from the date of Waiver No. 2 through the earlier to occur of (i) March 9, 2007, (ii) the date of delivery of the administrative agent or the lenders of any modified or restated version of the Company’s financial statements for its fiscal year ended January 31, 2006 or fiscal quarter ended April 30, 2006 (the “Previous Financial Statements”) which is in the reasonable opinion of the required lenders, materially adversely deviates from the original version thereof in a manner that negatively impacts the creditworthiness of the Company and (iii) the date of the occurrence of any other default or event of default not waived by the Waiver. See Note 20 to the Consolidated Financial Statements for waivers provided subsequent to year end.

In addition, pursuant to Waiver No. 2, the commitments of the lenders to make loans other than the $215 million borrowed to date, and of the issuing bank to issue, amend, renew or extend any letter of credit, is suspended until the date of delivery to the administrative agent and the lenders of the (i) ratification and reaffirmation of the Previous Financial Statements or modified or restated versions of the Previous Financial Statements which, in a reasonable opinion of the required lenders , do not materially adversely deviate from the original version thereof in a manner that negatively impacts the creditworthiness of the Company, and (ii) the financial statements and compliance certificates for the quarters ended July 31, 2006 and October 31, 2006.

At January 31, 2007, the 4% Convertible Subordinated Notes (the “2006 Notes”) due December 15, 2006 had matured and were retired by the trustee in accordance with the Indenture. On September 25, 2006, the Company deposited $260.4 million as trust funds in trust with U.S. Bank National Association, as trustee under the Indenture governing the Company’s 4% Convertible Subordinated Notes due December 15, 2006 (the “2006 Notes”). In accordance with the Indenture, this deposit is an amount of cash sufficient to pay and discharge the entire indebtedness on the 2006 Notes for the principal and accrued interest to the date of maturity. Interest accrued for the Company on the deposited amount until the 2006 notes matured on December 15, 2006. On December 15, 2006, the 2006 Notes matured and the principal and the accrued interest were paid off with the trust funds deposited with the trustee under the Indenture governing the 2006 Notes.

In the first quarter of fiscal 2008, the Company entered into a Land Purchase and Sale Agreement (the “Land Agreement”) with Tishman Speyer Development Corporation (“Tishman”), pursuant to which the Company agreed to sell the San Jose Land to Tishman for $108.0 million. Under the terms of the Land Agreement, on February 27, 2007 Tishman delivered into escrow a non-refundable deposit in the amount of $15.0 million, and on March 29, 2007 the $93.0 million balance of the purchase price, in accordance with the terms and subject to typical conditions contained in the Land Agreement, including the delivery of deeds, title insurance and payment of closing costs. The purchase price net of the transaction costs was $106 million and resulted in a gain of approximately $1.0 due to the fact that the San Jose Land had been written down to a fair value of $105 million.

Also in the first quarter of fiscal 2008, the Company entered into a Purchase and Sale Agreement (the “Building Agreement”) with the The Sobrato Family Foundation and Sobrato-Sobrato Investments (collectively, “Sobrato”), pursuant to which the Company agreed to purchase a 17-story building and parking facilities located at 488 Almaden Boulevard, San Jose, California from Sobrato for $135.0 million. That facility is intended to be our new corporate headquarters. We delivered a $10 million deposit to Sobrato on March 1, 2007 and paid the $125.3 million balance of the purchase price on April 2, 2007, in accordance with the terms and subject to typical conditions contained in the Building Agreement, including the delivery of deeds, title insurance and payment of closing costs.

At January 31, 2007, the Company has utilized the majority of its net operating losses for U.S. tax reporting purposes. However, the Company will recognize a loss for tax purposes during the year ended January 31, 2008 on the sale of land that was held for its future headquarters. As a result, it is not anticipated that substantial cash payments for U.S. taxes will be required during the year.

Restricted cash represents collateral for our letters of credit. Short term restricted cash correlates with letters of credit that expire within one year.

 

80


Table of Contents

The following table of contractual obligations as of January 31, 2007 is as follows (in thousands):

 

Contractual Obligations

   Total
payments
due
   Fiscal
2008
   Fiscal
2009 and
2010
   Fiscal
2011 and
2012
   Fiscal
2013 and
thereafter

Other obligations

   $ 2,562    $ 2,445    $ 73    $ 44    $ —  

Notes payable

     215,000      —        215,000      —        —  

Operating leases

     197,155      46,623      69,900      44,105      36,527

Capital lease

     1,419      190      378      378      473
                                  

Total contractual obligations

   $ 416,136    $ 49,258    $ 285,351    $ 44,527    $ 37,000
                                  

The above table excludes obligations related to accounts payable, accrued liabilities incurred in the ordinary course of business, and any future rate variable interest obligations associated with contractual obligations shown above.

We do not have significant commitments under lines of credit, standby lines of credit, guarantees, standby repurchase obligations or other such arrangements.

In September 2001, March 2003, May 2004 and March 2005, the Board of Directors approved stock repurchases that in aggregate equaled $600.0 million of our common stock under a share repurchase program (the “Share Repurchase Program”). In fiscal 2003, 6.9 million shares were repurchased at a total cost of approximately $42.1 million. In fiscal 2004, an additional 8.0 million shares were repurchased at a total cost of approximately $81.2 million. In fiscal 2005, 20.6 million shares were repurchased at a total cost of $161.3 million. In fiscal 2006, 22.5 million shares were repurchased at a total cost of $193.7 million. There were no shares repurchased in fiscal 2007, leaving approximately $121.7 million available for repurchase at January 31, 2007 under the Share Repurchase Program. An additional $500 million was approved by the Board of Directors in May 2007, resulting in a remaining $621.7 million available for repurchase under the Share Repurchase Program.

Off-Balance Sheet Arrangements

We do not use off-balance-sheet arrangements with unconsolidated entities or related parties, nor do we use other forms of off-balance-sheet arrangements such as research and development arrangements. Accordingly, our liquidity and capital resources are not subject to off-balance-sheet risks from unconsolidated entities. As of January 31, 2007, we did not have any off-balance-sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

We have entered into operating leases for most U.S. and international sales and support offices and certain equipment in the normal course of business. These arrangements are often referred to as a form of off-balance sheet financing. As of January 31, 2007, we leased facilities and certain equipment under non-cancelable operating leases expiring between 2007 and 2016. Rent expense under operating leases for fiscal 2007, fiscal 2006, and fiscal 2005 was $44.8 million, $40.4 million and $38.7 million, respectively. Future minimum lease payments under our operating leases as of January 31, 2007 are detailed previously in the minimum contractual obligations table above.

Critical Accounting Policies and Estimates

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and judgments that significantly affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. We regularly evaluate these estimates, and believe that the following accounting policies are critical to understanding our historical and future performance, as these policies relate to the more significant areas

 

81


Table of Contents

involving our judgments and estimates: revenue recognition, allowance for doubtful accounts, income taxes, facilities consolidation charges, intangible assets and goodwill, and impairment of long-lived assets. We base these estimates and judgments on historical experience and on assumptions that are believed by management to be reasonable under the circumstances. Actual results may differ from these estimates, which may impact the carrying values of assets and liabilities.

Our management has reviewed our critical accounting policies, our critical accounting estimates, and the related disclosures with our Audit Committee of the Board of Directors. These policies, and our procedures related to these policies, are described in detail below. In addition, please refer to Note 1 of the Notes to Consolidated Financial Statements for a further description of our accounting policies.

Revenue recognition. The Company recognizes revenues in accordance with the American Institute of Certified Public Accountants (“AICPA”) Statement of Position 97-2, Software Revenue Recognition, as amended.

Revenue from software license agreements is recognized when the basic criteria of software revenue recognition have been met (i.e. persuasive evidence of an agreement exists, delivery of the product has occurred, the fee is fixed or determinable, and collection is probable). The Company uses the residual method to recognize revenue when a license agreement includes one or more elements to be delivered at a future date and vendor specific objective evidence of the fair value of all undelivered elements exists. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as license revenue. If evidence of the fair value of one or more undelivered elements does not exist, all revenue is deferred and recognized when delivery of those elements occurs or when fair value can be established.

Vendor specific objective evidence of the fair value of customer support is determined by the price paid by the Company’s customers when customer support is sold separately (i.e. the prices paid by the customers in connection with renewals). Vendor specific objective evidence of fair value of consulting services and education is based on the price when sold separately.

When licenses are sold together with consulting services, license fees are recognized upon delivery, provided that (1) the basic criteria of software revenue recognition have been met, (2) payment of the license fees is not dependent upon the performance of the consulting services, and (3) the consulting services do not provide significant customization of the software products and are not essential to the functionality of the software that was delivered. The Company does not normally provide significant customization of its software products.

Revenue arrangements with extended payment terms are generally considered not to be fixed or determinable and, the Company generally does not recognize revenue on these arrangements until the customer payments become due and all other revenue recognition criteria have been met. In certain countries where collection risk is considered to be high, such as certain Latin American, Asian and Eastern European countries, revenue is generally recognized upon receipt of cash and in some cases, proof of delivery to the end user.

The Company has a number of strategic partnerships that represent the indirect channel including, system platform companies, packaged application software developers, application service providers, system integrators and independent consultants and distributors. Fundamentally, partners either embed or do not embed our software into their own software products. Partners who embed our software are referred to as Embedded Independent Software Vendors (“ISVs”), and revenue is recognized upon delivery of our software assuming all other revenue recognition criteria have been met. Partners who do not embed our software are generally referred to as Resellers. Due to the particular risk of concessions with respect to transactions with resellers, the Company recognizes revenue once persuasive evidence of sell through to an end user is received and all other criteria have been met. The Company’s partner license agreements do not provide for rights of return.

Services revenue includes revenues for consulting services, customer support and education. Consulting services revenue and the related cost of services are generally recognized on a time and materials basis. Revenues

 

82


Table of Contents

from fixed price consulting contracts are recognized as services are performed on a proportional performance basis. The total amount of revenue recognized under fixed price consulting contracts has been minimal to date. BEA’s consulting arrangements do not include significant customization of the software since the software is essentially a pre-packaged “off the shelf” platform that applications are built on or attached to. Customer support agreements provide technical support and the right to unspecified future upgrades on an if-and-when available basis. Customer support and maintenance revenues are recognized ratably over the term of the support period (generally one year). Education services revenue are recognized as the related training services are delivered. The unrecognized portion of amounts billed in advance of delivery for services is recorded as deferred revenue.

The Company occasionally purchases software products from vendors who are also customers. These transactions have not been frequent. In such transactions involving the exchange of software products, fair value of the software sold and purchased can not be reasonably estimated. As a result, the Company records such transactions at carryover (i.e. net) basis.

Allowance for Doubtful Accounts. We make judgments as to our ability to collect outstanding receivables and record allowances when collection becomes doubtful due to liquidity and non-liquidity concerns. The allowance includes both (1) an estimate for uncollectible receivables due to customers’ liquidity concerns and (2) an estimate for uncollectible receivables due to non-liquidity types of concerns. These estimates are based on assessing the credit worthiness of our customers based on multiple sources of information and analysis of such factors as our historical collection experience, collection experience within our industry, industry and geographic concentrations of credit risk, and current economic trends. The allowance charges associated with non-liquidity concerns are recorded as reductions to revenue and allowance charges associated with liquidity concerns are recorded as general and administrative expenses. This assessment requires significant judgment. If the financial condition of our customers were to worsen, additional allowances may be required; resulting in future operating losses that are not included in the allowance for doubtful accounts at January 31, 2007. To date, our actual losses have been within our expectations.

Income TaxesRealization of our deferred tax assets is primarily dependent on future U.S. taxable income. FAS 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. As a result of recent U.S. operating results, as well as U.S. jurisdictional forecasts of taxable income, we believe that net deferred tax assets in the amount of $218.0 million are realizable based on the “more likely than not” standard required for recognition.

BEA is a U.S. based multinational company subject to tax in multiple U.S. and foreign tax jurisdictions. The Company’s provision for income taxes is based on jurisdictional mix of earnings, statutory rates, and enacted tax rules, including transfer pricing. Significant judgment is required in determining the Company’s provision for income taxes and in evaluating its tax positions on a worldwide basis. The Company believes its tax positions, including intercompany transfer pricing policies, are consistent with the tax laws in the jurisdictions in which it conducts its business. It is possible that these positions may be challenged, which may have a significant impact on the Company’s effective tax rate.

Business Combinations. We are required to allocate the purchase price of acquired companies to the tangible and intangible assets acquired, liabilities assumed, as well as IPR&D based on their estimated fair values. We engage independent third party appraisal firms to assist us in determining the fair values of certain assets acquired and liabilities assumed for significant acquisitions. This valuation requires management to make significant estimates and assumptions, especially with respect to long-lived and intangible assets.

Critical estimates in valuing certain of the intangible assets include but are not limited to: future expected cash flows from license sales, maintenance agreements, consulting contracts, customer contracts and acquired developed technologies and patents; expected costs to develop the IPR&D into commercially viable products and estimating cash flows from the projects when completed; the acquired company’s brand awareness and market position, as well as assumptions about the period of time the brand will continue to be used in the combined

 

83


Table of Contents

company’s product portfolio; and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable and based on historical experience and information obtained from the management of the acquired companies, however these assumptions are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur.

The fair value of the deferred support obligation is based, in part, on a valuation completed by a third party appraiser using estimates and assumptions provided by management. The estimated fair value of the support obligation is determined utilizing a cost build-up approach. The cost build-up approach determines fair value by estimating the costs relating to fulfilling the obligation plus a normal profit margin. The sum of the costs and operating profit approximates, in theory, the amount that the Company would be required to pay a third party to assume the support obligation. The estimated costs to fulfill the support obligation were based on the historical direct costs related to providing the support services and to correct any errors in the acquired company’s software products. We do not include any costs associated with selling efforts or research and development or the related fulfillment margins on these costs. Profit associated with selling effort is excluded because acquired companies conclude the selling effort on the support contracts prior to the acquisition date. The estimated research and development costs are not included in the fair value determination, as these costs are not deemed to represent a legal obligation at the time of acquisition.

IPR&D represents incomplete research and development projects that had not reached technological feasibility and had no alternative future use when a company is acquired. Technological feasibility is established when an enterprise has completed all planning, design, coding and testing activities that are necessary to establish that a product can be produced to meet its design specifications including functions, features and technical performance requirements.

The value assigned to IPR&D is determined by considering the importance of the project to the overall development plan, estimating cost to develop the acquisition related IPR&D into commercially viable products, estimating the resulting net cash flows from the project when completed and discounting the net cash flows to their present value based on the percentage of completion of the IPR&D project.

In addition, other estimates associated with the accounting for these acquisitions may change as additional information becomes available regarding the assets acquired and liabilities assumed. In particular, liabilities to restructure the pre-acquisition organization, including workforce reductions are subject to change as management completes its assessment of the pre-merger operations and begins to execute the approved plan. These assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur.

Facilities Consolidation Charges. In fiscal 2002 and fiscal 2005, we recorded a facilities consolidation charge for our estimated future lease commitments on excess facilities, net of estimated future sublease income. The estimates used in calculating the charge are reviewed on a quarterly basis and would be revised if estimated future vacancy rates and sublease rates varied from our original estimates. To the extent that our new estimates vary adversely from our original estimates, we may incur additional losses that are not included in the accrued balance at January 31, 2007. Conversely, unanticipated improvements in vacancy rates or sublease rates, or termination settlements for less than our accrued amounts, may result in a reversal of a portion of the accrued balance and a benefit on our statement of income in a future period. The maximum future cost associated with these excess facilities, assuming that no future sublease income is realized on these properties, other than for subleases that have been executed prior to January 31, 2007, and assuming that the landlords are unwilling to negotiate early lease termination arrangements, is estimated to be $10.5 million, which exceeds the accrued balance at January 31, 2007 by $2.4 million.

Intangible Assets and Goodwill. We record intangible assets when we acquire other companies. The cost of an acquisition is allocated to the assets and liabilities acquired, including identified intangible assets, with the remaining amount being classified as goodwill. Certain intangible assets such as purchased technology and non-compete agreements are amortized over time. Goodwill is not amortized but rather it is periodically assessed

 

84


Table of Contents

for impairment. The allocation of the acquisition cost to intangible assets and goodwill therefore has a significant impact on our future operating results. The allocation process requires the extensive use of estimates and assumptions, including estimates of future cash flows expected to be generated by the acquired assets. Further, when impairment indicators are identified with respect to previously recorded intangible assets, the values of the assets are determined using discounted future cash flow techniques. Significant management judgment is required in the forecasting of future operating results which are used in the preparation of the projected discounted cash flows and should different conditions prevail, material write-downs of net intangible assets could occur. We periodically review the estimated remaining useful lives of our acquired intangible assets. A reduction in our estimate of remaining useful lives, if any, could result in increased amortization expense in future periods.

We test goodwill for impairment in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“FAS 142”). Under FAS 142, goodwill is tested for impairment in a two-step process. First, we determine if the carrying amount of our Reporting Unit exceeds the “fair value” of the Reporting Unit, which may initially indicate that goodwill could be impaired. If we determine that such impairment could have occurred, we would compare the “implied fair value” of the goodwill as defined by FAS 142 to its carrying amount to determine the impairment loss, if any.

Impairment of Long-Lived Assets. We are required to test certain of our long-lived assets for impairment under Statement of Financial Accounting Standards No. 144, Accounting for the Impairment and Disposal of Long-Lived Assets (“FAS 144”), whenever events or circumstances indicate that the value of the assets may be permanently impaired.

During the fourth quarter of fiscal 2007, we evaluated our facilities options and strategy with respect to our leased corporate headquarters in San Jose, California, whose leases expire in July 2008. Based on the results of this evaluation, we decided not to pursue developing the San Jose Land for use as our corporate headquarters. Accordingly, we concluded that we should test the San Jose Land for impairment in accordance with the guidance set forth in Statement of Financial Accounting Standards No. 144, Accounting for the Impairment and Disposal of Long-Lived Assets (“FAS 144”).

In accordance with FAS 144, if we determine that one or more impairment indicators are present, indicating that the carrying amount may not be recoverable, the carrying amount of the asset would be compared to net future undiscounted cash flows that the asset is expected to generate. If the carrying amount of the asset is greater than the net future undiscounted cash flows that the asset is expected to generate, the fair value would be compared to the carrying value of the asset. If the fair value is less than the carrying value, an impairment loss would be recognized. The impairment loss would be the excess of the carrying amount of the asset over its fair value.

We performed the aforementioned test and concluded that the San Jose Land, which had previously been held as a long-lived asset, was impaired. We determined that the fair value of the San Jose Land was $105.0 million at January 31, 2007, therefore triggering a write-down due to impairment in fiscal 2007 of $201.6 million.

Stock-Based Compensation. The Company accounts for stock-based compensation in accordance with FAS No. 123R. Under the provisions of FAS No. 123R, stock-based compensation cost is estimated at the grant date based on the award’s fair value as calculated by the Black-Scholes-Merton (“BSM”) option –pricing model and is recognized as expense ratably over the requisite service period. The BSM model requires various highly judgmental assumptions including volatility, forfeiture rates, and expected option life. If any of the assumptions used in the BSM model change significantly, stock-based compensation expense may differ materially in the future from that recorded in the current period.

In connection with the Company’s restatement of its consolidated financial statements, the Company has applied judgment in choosing whether to revise measurement dates for prior option grants. Information regarding

 

85


Table of Contents

the restatement, including ranges of possible additional stock-based compensation expense if other measurement dates had been selected for certain grants, is set forth in the “Explanatory Note” immediately preceding Part I, Item 1 and in Note 2, “Restatement of Consolidated Financial Statements” in Notes to Consolidated Financial Statements of this Form 10-K.

Contingencies and Litigation. We evaluate contingent liabilities including threatened or pending litigation in accordance with FAS No. 5, “Accounting for Contingencies” (“FAS 5”). We assess the likelihood of any adverse judgments or outcomes to a potential claim or legal proceeding, as well as potential ranges of probable losses, when the outcomes of the claims or proceedings are probable and reasonably estimable. A determination of the amount of accrued liabilities required, if any, for these contingencies is made after the analysis of each matter. Because of uncertainties related to these matters, we base our estimates on the information available at the time. As additional information becomes available, we reassess the potential liability related to its pending claims and litigation and may revise our estimates. Any revisions in the estimates of potential liabilities could have a material impact on our results of operations and financial position.

Related Party Transactions

Common Board Members or Executive Officers

We occasionally sell software products or services to companies that have board members or executive officers who are also on our Board of Directors. The total revenues recognized by us from such customers in fiscal 2007, fiscal 2006 and fiscal 2005 were $ 1.7 million, $1.9 million and $1.1 million, respectively.

Effect of New Accounting Pronouncements

In September 2006, the FASB issued FAS No. 157, “Fair Value Measurements.” This Statement defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practice. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We will adopt this statement effective February 1, 2008. We do not believe the adoption of FAS157 will have a material impact on our consolidated financial position, results of operations and cash flows

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FAS 109, Accounting for Income Taxes” (“FIN 48”), to create a single model to address accounting for uncertainty of tax positions. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting for interim periods, disclosure and transition.

FIN 48 is effective for fiscal years beginning after December 15, 2006. We adopted FIN 48 as of February 1, 2007, as required. The cumulative effect of adopting FIN 48 will be recorded in retained earnings. We expect to have the following impact on our financial position and results of operations. Upon initial adoption, the expected cumulative effect of applying the provisions of FIN 48 is an increase in tax liabilities of $10 million. This will be reported as an adjustment to the opening balance of retained earnings. There may be an affect to the effective income tax rate in future years along with greater volatility due to the adoption of FIN 48.

In September 2006, the FASB issued FAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—An Amendment of FASB No. 87, 88, 106 and 132(R.) FAS No. 158 requires that the funded status of defined benefit postretirement plans be recognized on the company’s balance sheet, and changes

 

86


Table of Contents

in the funded status be reflected in comprehensive income, effective fiscal years ending after December 15, 2006, which we adopted effective February 1, 2007. FAS No. 158 also requires companies to measure the funded status of the plan as of the date of its fiscal year end, effective for fiscal years ending after December 15, 2008. We expect to adopt the measurement provisions of FAS No. 158 effective February 1, 2009. Based upon our January 31, 2007 balance sheet and with insignificant foreign pension plan obligations, we do not expect the adoption of FAS No. 158 to have a material impact on our results of operations and financial position.

In February 2007, the FASB issued FAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (“FAS 159”). FAS 159 is expected to expand the use of fair value accounting but does not affect existing standards which require certain assets or liabilities to be carried at fair value. The objective of FAS 159 is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Under FAS 159, a company may choose, at specified election dates, to measure eligible items at fair value and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. FAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently assessing the impact that FAS 159 may have on our results of operations and financial position

In September 2006, the SEC released SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB No. 108 provides interpretive guidance on the SEC’s views regarding the process of quantifying materiality of financial statement misstatements. SAB No. 108 is effective for fiscal years ending after November 15, 2006, with early application for the first interim period ending after November 15, 2006. We adopted SAB No. 108 in the fourth quarter of fiscal year 2007. The adoption of SAB No. 108 has not had an impact on our results of operations or financial position.

In June 2007, the Financial Accounting Standards Board (“FASB”) ratified EITF 07-3, Accounting for Non-Refundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities, (“EITF 07-3”). EITF 07-3 requires that nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities be deferred and capitalized and recognized as an expense as the goods are delivered or the related services are performed. EITF 07-3 is effective, on a prospective basis, for fiscal years beginning after December 15, 2007 and will be adopted by the Company in the first quarter of fiscal 2009. The Company is currently evaluating the impact, if any, EITF 07-3 will have on its consolidated results of operations and financial condition.

 

87


Table of Contents
ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.

Foreign Exchange

Our revenues originating outside the Americas (U.S., Canada, Mexico and Latin America) were 46.4 percent, 48.1 percent and 50.3 percent of total revenues in fiscal 2007, fiscal 2006 and fiscal 2005, respectively. International revenues from each individual country outside of the United States were less than 10 percent of total revenues in fiscal 2007, fiscal 2006, and fiscal 2005 with the exception of United Kingdom with $130.0 million or 10.8 percent of the total revenues in fiscal 2006 and $138.9 million or 12.9 percent of the total revenues in fiscal 2005. International sales were made mostly from our foreign sales subsidiaries in the local countries and are typically denominated in the local currency of each country. Fluctuations in the Euro, British Pound and Yen would have the most impact on our future results of operations. These subsidiaries also incur most of their expenses in the local currency. Accordingly, foreign subsidiaries use the local currency as their functional currency.

Our international operations are subject to risks typical of an international business, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, export license restrictions, other regulations and restrictions, and foreign exchange volatility. Accordingly, our future results could be materially adversely impacted by changes in these or other factors.

Our accounting exposure to foreign exchange rate volatility arises primarily from intercompany accounts between our parent company in the United States and our foreign subsidiaries. The remaining accounting exposure is a result of certain assets and liabilities denominated in foreign currencies other than their functional currency that require remeasurement. The intercompany accounts are typically denominated in the functional currency of the foreign subsidiary in order to centralize foreign exchange risk. The income statement exposure to currency fluctuations arises principally from revaluing our intercompany balances into U.S. dollars, with the resulting gains or losses recorded in other income and expense. The Company hedges its exposure to these profit and loss fluctuations by entering into forward exchange contracts. A forward foreign exchange contract obligates us to exchange predetermined amounts of specified foreign currencies at specified exchange rates on specified dates or to make an equivalent U.S. dollar payment equal to the value of such exchange. The gains or losses from the forward contracts are designed to approximately offset the gains or losses from revaluing the intercompany accounts. Based upon recent intercompany balance levels and exchange rate fluctuations, our intercompany gains or losses net of the associated forward exchange gains or losses, result in quarterly gain or loss fluctuations in other income and expense of up to approximately $0.2 million. At January 31, 2007, our transaction exposures amounted to $60.0 million and were offset by foreign currency forward contracts with a net notional amount of $18.8 million. Based on exposures at January 31, 2007, a 10 percent movement against our portfolio of transaction exposures and hedge contracts would result in a gain or loss of approximately $4.2 million. We do not use foreign currency contracts for speculative or trading purposes. All outstanding forward contracts are marked-to-market on a monthly basis with gains and losses included in interest and other, net. Net losses resulting from foreign currency transactions were approximately $0.2 million, $1.4 million and $1.1 million for fiscal 2007, fiscal 2006 and fiscal 2005, respectively.

We are also exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into U.S. dollars for consolidation purposes. As exchange rates vary, these results, when translated, may vary from expectations and may adversely impact overall financial results.

 

88


Table of Contents

Our outstanding forward contracts as of January 31, 2007 are presented in the table below and are recorded on the balance sheet as part of accrued liabilities. All forward contracts amounts are representative of the expected payments to be made under these instruments. The fair market value of the contracts below represents the difference between the spot rate at January 31, 2007 and the contracted rate. All of these forward contracts mature within 63 days or less as of January 31, 2007.

 

     Local
currency
contract
amount
        Contract
amount
       Fair market
value at
January 31,
2007 (USD)
 
     (in thousands)         (in thousands)        (in thousands)  

Contract to Buy US $

           

Australian dollars

   (19,000 )   AUD   14,860    USD   $ (129 )

Brazilian reals

   (5,200 )   BRL   2,393    USD     (9 )

British pounds

   (250 )   GBP   490    USD     (1 )

Chinese yuan

   (10,300 )   CNY   1,333    USD     50  

Euros

   (52,649 )   EUR   68,241    USD     (1,483 )

Indian rupee

   (722,400 )   INR   16,185    USD     141  

Japanese yen

   (1,250,000 )   JPY   10,470    USD     (177 )

Korean won

   (48,400,000 )   KRW   51,957    USD     (120 )

Mexican peso

   (79,000 )   MXN   7,169    USD     (36 )
                 
            $ (1,764 )
                 

Contract to Sell US $

           

Australian dollar

   7,900     CNY   6,247    USD   $ (15 )

British Pounds

   34,500     GBP   67,563    USD     270  

Canadian dollar

   17,900     CAD   15,340    USD     355  

Chinese yuan

   36,500     CNY   4,708    USD     (160 )

Danish kroner

   10,000     DKK   1,738    USD     38  

Euro

   40,220     EUR   52,128    USD     1,135  

Indian rupee

   378,700     INR   8,577    USD     (167 )

Israeli shekel

   5,000     ILS   1,188    USD     (26 )

Korean won

   24,200,000     KRW   25,711    USD     327  

Mexican peso

   47,000     MXN   4,303    USD     (17 )

Singapore dollar

   15,900     SGD   10,339    USD     (282 )

Swedish krona

   15,200     SEK   2,173    USD     46  

Swiss franc

   3,800     CHF   3,061    USD     112  
                 
            $ 1,616  
                 

Contract to Buy Euro €

           

British pounds

   (25,650 )   GBP   38,738    EUR   $ 870  

Danish kroner

   (10,000 )   DKK   1,342    EUR     1  

Norwegian krone

   (6,000 )   NOK   718    EUR     (24 )

Swiss franc

   (3,250 )   CHF   2,019    EUR     (39 )

Swedish krona

   (17,500 )   SEK   1,929    EUR     (1 )
                 
            $ 807  
                 

Contract to Sell Euro €

           

British pounds

   11,400     GBP   17,270    EUR   $ (457 )
                 

Total

            $ 202  
                 

 

89


<