================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q (Mark One) X Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange - --- Act of 1934 For the quarterly period ended April 30, 1999 OR ___ Transition report pursuant 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 (I. R. S. Employer incorporation or organization) 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) 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 X No __ --- As of May 31, 1999, there were approximately 59,350,000 shares of the Registrant's Common Stock outstanding and 17,824,000 shares of Registrant's Class B Common Stock outstanding. ================================================================================ BEA SYSTEMS, INC. INDEX PART I. FINANCIAL INFORMATION Page No. -------- ITEM 1. Financial Statements (Unaudited): Condensed Consolidated Statements of Operations Three months ended April 30, 1999 and 1998......................................................... 3 Condensed Consolidated Balance Sheets April 30, 1999 and January 31, 1999............................................................... 4 Condensed Consolidated Statements of Cash Flows Three months ended April 30, 1999 and 1998......................................................... 5 Notes to Condensed Consolidated Financial Statements................................................. 6 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................................................... 8 ITEM 3. Quantitative and Qualitative Disclosure about Market Risks........................................... 23 PART II. OTHER INFORMATION ITEM 6. Exhibits and Reports on Form 8-K..................................................................... 24 Signatures..................................................................................................... 25 2 PART I. FINANCIAL INFORMATION ITEM I. FINANCIAL STATEMENTS BEA SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (in thousands, except per share data) (Unaudited) Three Months Ended April 30, ---------------------------------- 1999 1998 ------------ ----------- Revenues: License fees $ 55,906 $ 40,619 Services 29,669 17,910 ---------- --------- Total revenues 85,575 58,529 Cost of revenues: Cost of license fees 1,165 781 Cost of services 16,641 11,464 Amortization of certain acquired intangible assets 6,840 3,182 ---------- --------- Total cost of revenues 24,646 15,427 ---------- --------- Gross profit 60,929 43,102 Operating expenses: Sales and marketing 41,790 27,047 Research and development 12,044 10,493 General and administrative 9,107 5,929 Acquisition-related charges - 491 ---------- --------- Total operating expenses 62,941 43,960 ---------- --------- Loss from operations (2,012) (858) Interest income/(expense) and other, net (388) 332 ---------- --------- Loss before provision for income taxes (2,400) (526) Provision for income taxes 1,565 623 ---------- --------- Net loss (3,965) (1,149) Other comprehensive income/(loss): Foreign currency translation adjustments (310) 101 Unrealized loss on available-for-sale investments, net of income taxes (22) (21) ---------- --------- Comprehensive loss $ (4,297) $ (1,069) ========== ========= Basic and diluted net loss per share $ (0.05) $ (0.02) ========== ========= Shares used in computing basic and diluted net loss per share 75,750 67,379 ========== ========= See accompanying notes. 3 BEA SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) April 30, 1999 January 31, 1999 --------------- ------------------ (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 249,600 $ 232,556 Short-term investments 3,732 3,895 Accounts receivable, net 79,339 77,068 Other current assets 6,013 4,279 ----------- ----------- Total current assets 338,684 317,798 Computer equipment, furniture and leasehold improvements, net 19,657 17,185 Acquired intangible assets, net 51,072 58,901 Other assets 8,957 9,127 ----------- ----------- Total assets $ 418,370 $ 403,011 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Borrowing under lines of credit $ 679 $ 679 Accounts payable 10,430 7,615 Accrued liabilities 50,035 47,747 Accrued income taxes 5,862 5,991 Deferred revenues 47,192 33,784 Current portion of notes payable and capital lease obligations 56 43 ----------- ----------- Total current liabilities 114,254 95,859 Notes payable and other long-term obligations 397 112 Convertible subordinated notes 250,000 250,000 Commitments and contingencies Stockholders' equity: Common stock 77 77 Additional paid-in capital 243,885 243,097 Accumulated deficit (187,081) (183,116) Notes receivable from shareholders (544) (544) Deferred compensation (1,692) (1,880) Accumulated other comprehensive loss (926) (594) ----------- ----------- Total stockholders' equity 53,719 57,040 ----------- ----------- Total liabilities and stockholders' equity $ 418,370 $ 403,011 =========== =========== See accompanying notes. 4 BEA SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (Unaudited) Three Months Ended April 30, ------------------------- 1999 1998 ---------- ---------- Operating activities: Net loss $ (3,965) $ (1,149) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 1,865 609 Amortization of deferred compensation 188 197 Amortization of certain acquired intangible assets and acquisition-related charges 7,829 3,383 Amortization of debt issuance costs 261 - Changes in operating assets and liabilities 14,279 (2,586) Other (287) (30) ---------- ---------- Net cash provided by operating activities 20,170 424 ---------- ---------- Investing activities: Purchase of computer equipment, furniture and leasehold improvements (4,337) (871) Payments for business combinations, net of cash acquired - (1,575) Net maturities/(purchases) of available-for-sale short-term investments 141 (1,010) ---------- ---------- Net cash used in investing activities (4,196) (3,456) ---------- ---------- Financing activities: Net borrowings under lines of credit - 964 Net payments on notes payable and capital lease obligations (83) (4,351) Proceeds from issuance of common stock and preferred stock, net 788 12,122 ---------- ---------- Net cash provided by financing activities 705 8,735 ---------- ---------- Net increase in cash and cash equivalents 16,679 5,703 Effect of exchange rate changes on cash 365 101 Cash and cash equivalents at beginning of period 232,556 90,984 ---------- ---------- Cash and cash equivalents at end of period $ 249,600 $ 96,788 ========== ========== See accompanying notes. 5 BEA SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 1. Basis of Presentation The condensed consolidated financial statements included herein are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, together with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the BEA Systems, Inc. ("BEA" or the "Company") Annual Report on Form 10-K for the fiscal year ended January 31, 1999. The results of operations for the three months ended April 30, 1999 are not necessarily indicative of the results for the entire fiscal year ending January 31, 2000. The Company acquired Leader Group, Inc. ("Leader Group") on April 30, 1998 and WebLogic, Inc. ("WebLogic") on September 30, 1998 in merger transactions accounted for as poolings of interests. The results of operations for the three months ended April 30, 1998 have been restated to reflect the combined operations of the Company, Leader Group and WebLogic. The consolidated balance sheet at January 31, 1999 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Note 2. Earnings Per Share The Company has adopted Statement of Financial Accounting Standard No. 128, Earnings per Share ("FAS 128"). Under this standard, basic net loss per share is computed based on the weighted average number of shares of the Company's common stock. Diluted net loss per share is computed based on the weighted average number of shares of the Company's common stock and common equivalent shares (stock options, warrants, convertible notes and preferred stock), if dilutive. The following is a reconciliation of the numerators and denominators of the basic and diluted loss per share computations (in thousands, except per share data): Three months ended April 30, ------------------------- 1999 1998 ---------- ---------- Basic and diluted loss per share: Numerator: Net loss $ (3,965) $ (1,149) ========== ========== Denominator: Weighted average shares 76,853 69,217 Shares subject to repurchase (1,103) (1,838) ---------- ---------- Weighted average shares, net 75,750 67,379 ========== ========== Basic and diluted net loss per share $ (0.05) $ (0.02) ========== ========== The computation of basic and diluted net loss per share for the three months ended April 30, 1999 excludes the impact of the conversion of the 4% Convertible Subordinated Notes issued in June and July 1998 (See Note 3), which are convertible into 9,466,111 shares of common stock, as well as approximately 4.5 million stock options, as such impact would be antidilutive for the period presented. For the three months ended April 30, 1998, the net loss per share excludes the impact of approximately 321,000 stock options, as such would be antidilutive for the period presented. 6 Note 3. Convertible Subordinated Debt Offering In June and July, 1998, the Company completed the sale of $250 million of 4% Convertible Subordinated Notes ("Notes") due June 15, 2005 in an offering to Qualified Institutional Buyers. The Notes are subordinated to all existing and future senior indebtedness of the Company, and the principal amount of the Notes is convertible into common stock of the Company at a conversion rate of 37.87 shares per $1,000 principal amount of Notes (equivalent to an approximate conversion price of $26.41 per share). The Notes are redeemable at the option of the Company in whole or in part at any time on or after June 5, 2001, in cash plus accrued interest, if any, through the redemption date, subject to certain events. Interest is payable semi-annually. Note 4. Comprehensive Loss On February 1, 1998, the Company adopted Statement of Financial Accounting Standard No. 130, Reporting Comprehensive Income ("FAS 130"). This standard established new rules for the reporting and display of comprehensive loss and its components and requires unrealized gains or losses on the Company's available-for-sale securities and the foreign currency translation adjustments to be included in other comprehensive loss. The components of accumulated other comprehensive loss are as follows (in thousands): Three months Year ended ended April 30, January 31, ----------------- ----------------- 1999 1999 ----------------- ----------------- Foreign currency translation adjustment $ (877) $ (567) Unrealized loss on available-for-sale investments, net of tax (49) (27) --------- --------- Total accumulated other comprehensive loss $ (926) $ (594) ========= ========= Note 5. Industry and Geographic Segment Information Information regarding the Company's operations by geographic areas at April 30, 1999 and 1998 and for the three months then ended is as follows (in thousands): Three months ended April 30, ------------------------- 1999 1998 ---------- ---------- Total revenues United States $ 50,839 $ 27,772 Europe, Middle East and Africa (EMEA) 28,251 23,985 Asia/Pacific and other 6,485 6,772 ---------- ---------- $ 85,575 $ 58,529 ========== ========== Long-lived assets (at April 30): United States $ 75,313 $ 24,716 Europe, Middle East and Africa 2,892 2,620 Asia/Pacific and other 1,481 1,159 ---------- ---------- $ 79,686 $ 28,495 ========== ========== Within EMEA, France represented 11 percent of total revenues for the three months ended April 30, 1999. Note 6. Commitments and Contingencies The Company has been named in litigation involving alleged patent and copyright infringement claims. Based on information currently available, the ultimate resolution of the pending legal proceeding is not likely to have a material adverse effect on the Company's financial position. 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of the financial condition and results of operations of BEA Systems, Inc. should be read in conjunction with the Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and the Notes thereto included in the Company's Annual Report on Form 10-K for the year ended January 31, 1999. This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements using terminology such as "may," "will," "expects," "plans," "anticipates," "estimates," "potential," or "continue," or the negative thereof or other comparable terminology regarding beliefs, plans, expectations or intentions regarding the future. Forward-looking statements include statements regarding growth in the middleware market, consolidation of companies serving the middleware market and opportunities for BEA related thereto, future acquisitions or licensing transactions, building sales capacity and pursuing partnerships with other companies, future cost and expense levels, expected timing and amount of amortization expenses related to past acquisitions, the adequacy of resources to meet future cash requirements, future hiring, evaluation and resolution of the Year 2000 problem, and expenses associated with the Year 2000 problem. These forward-looking statements involve risks and uncertainties and actual results could differ materially from those discussed in the forward-looking statements. These risks and uncertainties include, but are not limited to, those described under the headings "Year 2000 Compliance" and "Factors That May Impact Future Operating Results." All forward-looking statements and risk factors included in this document are made as of the date hereof, based on information available to BEA as of the date thereof, and BEA assumes no obligation to update any forward-looking statement or risk factors. Overview BEA Systems, Inc. ("BEA" or the "Company") is a leading provider of cross- platform middleware solutions for enterprise applications. BEA's products and services help enable mission-critical distributed applications to work seamlessly in client/server, Internet, and legacy environments. BEA provides transactional, messaging, and distributed object-based software, as well as an industry-leading Java Web application server, for developing and deploying these enterprise applications. The newly expanded BEA WebLogic product suite provides component-based application servers for delivering mission-critical, Web-enabled applications. In addition to its broad software product line, BEA provides complete solutions to its customers through its full range of services including consulting, training, and support and extensive partner network. BEA's revenues are derived from fees for software licenses, customer support, education and consulting services. Potential Spending Freeze Related to Year 2000. Industry sources widely predict that many large corporations will stop deploying new computer systems in late 1999 and early 2000, in order to avoid disrupting their computer systems before the year 2000. Large corporations represent the majority of BEA's customer base, and a material portion of our license fees come from new computer system deployments. BEA is monitoring its customer base, especially customers expected to place orders in late 1999, to determine their plans and have been informed by some of our customers that they intend to freeze. Many of these customers have informed BEA that they do not plan to freeze deployments, or do not plan to freeze projects involving BEA products. As a result, BEA believes that its business will not be materially affected by the anticipated freeze. However, BEA is also taking several management steps to reduce our exposure to a freeze in deployments, such as providing special incentives to our sales force during this time and focussing on transactions that are not dependent on new deployments of pending projects. However, if the freeze in deployments is larger than we anticipate, starts earlier or lasts longer than we anticipate, or affects our targeted customers to a greater degree than we anticipate, our revenues in late 1999 or early 2000 could be materially lower than expected. See "--Factors That May Impact Future Operating Results--Potential Fluctuations in Quarterly Operating Results." Acquisitions. Since its inception, BEA has acquired several companies and product lines, and distribution rights to product lines. Through these acquisitions, BEA has added additional product lines, additional functionality to its existing products, additional direct distribution capacity and additional service capacity. These acquisitions have resulted in significant charges to BEA's operating results in the periods in which the acquisitions were completed and have added intangible assets to BEA's balance sheet, the value of which is being amortized and charged to 8 BEA's operating results over periods ranging from four to ten quarters after completion of the acquisitions. BEA's management views the middleware market as growing but that companies serving that market are consolidating, and that this consolidation presents an opportunity for BEA to further expand its product lines and functionality, distribution capacity and services offerings and to add new, related lines of business. BEA anticipates that it will make additional, perhaps material, acquisitions in the future. The timing of any such acquisition is impossible to predict and the charges associated with any such acquisition could materially adversely affect BEA's results of operations beginning in the periods in which any such acquisition is completed. Investment in Distribution Channel. BEA is currently investing in building its sales capacity by aggressively hiring sales and technical sales support personnel, as well as aggressively pursuing partnerships with system platform companies, packaged application software developers, systems integrators and independent consultants, independent software tool vendors, and distributors. This investment results in an immediate increase in expenses, especially in sales and marketing, although the return on such investments, if any, is not anticipated to occur until future periods. BEA eSolutions. In April 1999, BEA announced the formation of a concentration on developing and marketing a set of solutions for enterprise application integration and application development, especially in the area of electronic commerce. BEA's planned investment in this effort may affect BEA's anticipated overall financial results, particularly services revenues as a percentage of total revenues, cost of revenues as a percentage of total revenues, and research and development expense as a percentage of total revenues. In addition, investment in this project results in an immediate increase in expenses, especially in research and development, although the return on such investment, if any, is not anticipated to occur until future periods. The expenses adversely affect BEA's operating results in the short term and also in the long term if the anticipated benefits of such investment do not materialize. Change in Sales Cycles. Since mid fiscal 1999, BEA has experienced changes in sales cycles for its products. In September 1998, BEA completed its merger with WebLogic, Inc. ("WebLogic"), whose products tend to have a shorter sales cycle than BEA's enterprise application solutions. During the second half of fiscal 1999, an increasing number of BEA customers began negotiating licenses to use BEA's enterprise application solutions products as an architectural platform for several applications. These architectural commitments are larger in scope and potential revenue than single project transactions. In some cases, these architectural commitments have longer sales cycles than BEA's typical transactions, both because of the customer's decision cycle in adopting an architectural platform and because of heightened corporate approval requirements for larger contracts. In some cases, architectural commitment transactions have a shorter than usual sales cycle, in order for the customer to proceed with development of the new applications. These contrasting changes in the sales cycles and product mix may affect BEA's future quarterly revenues, revenue mix and operating results. Results of Operations Revenues BEA's revenues are derived from fees for software licenses, customer support, education and consulting services. Total revenues increased $27.0 million or 46 percent from the quarter ended April 30, 1998 to the quarter ended April 30, 1999. The increase reflects additional sales to existing customers, addition of new customer accounts and an increase in service offerings. License Revenues. License revenues increased 38 percent from the first quarter of fiscal 1999 to the first quarter of fiscal 2000. The increase in license revenues was mainly due to continued customer and market acceptance of the Company's products, and expansion of the Company's direct sales force. License revenues as a percentage of total revenues represented 65 percent and 69 percent of total revenues in the first quarter of fiscal 2000 and 1999, respectively. The decrease was attributable to the increase in service revenues as a result of the Company's increased focus on its service offerings. Service Revenues. Service revenues increased 66 percent in the first quarter of fiscal 2000 compared with the same quarter in fiscal 1999. Service revenues as a percentage of total revenues increased to 35 percent in the first quarter of fiscal 2000 from 31 percent in the first quarter of fiscal 1999. The increases were primarily due to 9 increased charges for customer support resulting from increased license sales, an increase in consulting services offered by the Company, and increased numbers of service personnel and consultants. International Revenues. International revenues accounted for $34.7 million or 41 percent of total revenue in the quarter ended April 30, 1999 compared with $30.8 million or 53 percent in the same quarter of the prior fiscal year. The increase in international revenue dollars was the result of expansion of the Company's international sales force. Revenues from the European, Middle East and Africa region (EMEA) and Asia/Pacific region (APAC) increased in the first quarter of fiscal 2000 to $28.3 million and $6.3 million from $24.0 million and $5.9 million, respectively, in the same quarter of the prior fiscal year. Revenues from EMEA represented 33 percent of total revenues in the first quarter of fiscal 2000, compared with 41 percent in the same quarter of the prior fiscal year. Revenues from APAC represented 7 percent of total revenues in the first quarter of fiscal 2000, compared with 10 percent in the same quarter of the prior fiscal year. These decreases were the direct result of the expansion of the Company's domestic sales force and increased domestic revenue resulting from the acquisition of WebLogic. Cost of Revenues Total cost of revenues represented 29 percent and 26 percent of total revenues in the quarter ended April 30, 1999 and 1998, respectively. The increase was due to the increase in service revenues as a percentage of total revenues, which carry a substantially higher cost of revenue than software licenses. Increased amortization charges related to acquisitions included in cost of revenues also contributed to the increase. Cost of Licenses. Cost of licenses includes expenses related to the purchase of disks and compact discs, costs associated with transferring the Company's software to electronic media, the printing of user manuals, packaging and distribution costs. Cost of licenses represented 2 percent of license revenues for the first quarter of both fiscal 2000 and 1999. Cost of Services. Cost of services consists primarily of salaries and benefits for consulting, education and product support personnel. Cost of services increased 45 percent in the first quarter of fiscal 2000 compared to the same quarter of the prior fiscal year. This increase was the result of the expansion of customer support centers in Europe and Asia, overall increased demand for the Company's services, and increased professional services headcount. Cost of services represented 56 percent and 64 percent of service revenues in the quarter ended April 30, 1999 and 1998, respectively. Cost of services as a percentage of service revenues decreased primarily as a result of nonrecurring fixed costs associated with the fiscal 1999 expansion of support centers in Europe and Asia. In the future, management expects the cost of services as a percentage of services revenue to range between 55 percent and 65 percent, as the Company continues to build its support and service organization. Amortization of Certain Acquired Intangible Assets. The amortization of certain acquired intangible assets, consisting of developed technology, distribution rights, trademarks and tradenames, totaled $6.8 million and $3.2 million for the first quarter of fiscal years 2000 and 1999, respectively. The increase was primarily due to intangible assets resulting from a number of strategic acquisitions, particularly the fiscal 1999 acquisition of the TOP END products and the fiscal 1998 acquisition of the MessageQ and ObjectBroker products. In the future, amortization expense associated with these intangible assets recorded through April 30, 1999 is expected to total $6.8 million, $6.7 million and $6.5 million for the second, third and fourth quarter of fiscal 2000, approximately $21.6 million, $1.2 million, and $350,000 for the fiscal years ending January 31, 2001, 2002 and thereafter, respectively. Operating Expenses Sales and Marketing. Sales and marketing expenses include salaries, benefits, sales commissions, travel, and facility costs for the Company's sales and marketing personnel. These expenses also include programs aimed at increasing revenues, such as advertising, public relations, trade shows and user conferences. Sales and marketing expenses increased 55 percent in the first quarter of fiscal 2000 compared with the same quarter of the prior fiscal year. These expenses represented 49 percent and 46 percent of total revenues for the quarter ended April 30, 1999 and 1998, respectively. Sales and marketing expenses increased due to increased commissions on the Company's 10 increased revenue base, the expansion of the Company's direct sales force and an increase in marketing personnel and programs. The Company expects to continue to invest in sales channel expansion and marketing programs to promote the Company's products. Accordingly, the Company expects sales and marketing expenses to continue to increase in future periods in absolute dollars. Research and Development. Research and development expenses consist primarily of salaries and benefits for software engineers, contract development fees, costs of computer equipment used in software development and facilities expenses. Total expenditures for research and development increased 15 percent in the first quarter of fiscal 2000 compared with the same quarter in fiscal 1999. Research and development expenses represented 14 percent and 18 percent of total revenues in the first quarter of fiscal 2000 and 1999, respectively. The increase in research and development spending in absolute dollars was attributed to an increase in software development personnel and related expenses. The decrease in research and development expenses as a percentage of total revenues was primarily due to the substantial increase in license and service revenues. The Company expects to continue to commit substantial resources to product development and engineering in future periods. As a result, the Company expects research and development expenses to continue to increase in absolute dollars in future periods. Additionally, management intends to continue recruiting and hiring experienced software development personnel and to consider the licensing and acquisition of technologies complementary to the Company's business. General and Administrative. General and administrative expenses include costs for the Company's human resources, finance, information technology, facilities and general management functions, as well as the amortization of goodwill associated with various acquisitions. General and administrative expenses increased 54 percent in the first quarter of fiscal 2000 compared with the same quarter of fiscal 1999. General and administrative expenses represented 10 percent of total revenues for both quarters ended April 30, 1999 and 1998, respectively. The increase in general and administrative spending was attributed to the expansion of the Company's support infrastructure, including information systems and associated expenses necessary to manage the Company's growth. Goodwill amortization totaled $989,000 and $201,000 in the first quarter of fiscal 2000 and 1999, respectively. In the future, amortization of goodwill recorded prior to April 30, 1999 is expected to total $989,000 for each of the remaining quarters in fiscal 2000, approximately $3.5 million, $1.4 million and $20,000 for fiscal years ending January 31, 2001, 2002 and thereafter, respectively. Acquisition related charges. In fiscal 1999, acquisition related charges were primarily related to expenses associated with the acquisition of Leader Group, Inc. ("Leader"). Interest Expense; Interest Income and Other, Net. Interest expense was $2.5 million in the first quarter of fiscal 2000, compared with $1.1 million in the same quarter of the prior fiscal year. The increase was due to a higher average amount of outstanding borrowings, primarily due to the issuance of $250 million four percent Convertible Subordinated Notes ("Notes"). Interest income and other, net was $2.1 million and $1.4 million in the first quarter of fiscal 2000 and 1999, respectively. The increase in interest income was due to the investment of higher average cash, cash equivalents and short-term investment balances, generated primarily from the Company's debt and equity offerings. Provision for Income Taxes. While the Company has experienced operating losses to date, the Company has incurred income tax expense of approximately $1.6 million and $623,000 in the first quarters of fiscal years 2000 and 1999, respectively. The income tax expense consists primarily of domestic minimum taxes, foreign withholding taxes and foreign income tax expense incurred as a result of local country profits. The increase in income taxes in the first quarter of fiscal 2000, relative to the same quarter of the prior fiscal year was primarily due to an overall increase in foreign corporate income taxes. 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. Based upon the available evidence, which includes BEA's historical operating performance and the reported cumulative net losses from prior years, the Company has provided a full valuation allowance against its net deferred tax assets. The Company intends to evaluate the realizability of the deferred tax assets on a quarterly basis. 11 Liquidity and Capital Resources As of April 30, 1999, total cash, cash equivalents and short-term investments totaled $253.3 million, up from $236.5 million at January 31, 1999. The increase in cash, cash equivalents and short-term investments was primarily due to cash generated from operations. Cash generated from operating activities rose to $20.1 million in the first quarter of fiscal 2000, compared with $424,000 generated in the same quarter of the prior fiscal year. The primary source of cash generated from operations was an increase in deferred revenue and net income adjusted for non-cash transactions including depreciation and amortization. Investing activities consumed $4.2 million in cash during the first quarter of fiscal 2000, compared with $3.5 million in the same quarter of the prior fiscal year. Cash used for investing activities in the first quarter of fiscal 2000 was primarily due to purchases of computer equipment, furniture and leasehold improvements. In the same quarter of the prior fiscal year the primary use of cash for investing activities was due to the acquisition of certain assets of Penta Systems Technology, Inc. ("Penta"). The Company generated $705,000 from financing activities in the first quarter of fiscal 2000, compared with $8.7 million in the same quarter of the prior fiscal year. The primary source of cash from financing activities in the first quarter of fiscal 2000 was the issuance of common stock by BEA and in the first quarter of fiscal 1999 was the issuance of preferred stock by WebLogic prior to BEA's acquisition of WebLogic. As of April 30, 1999, the Company's outstanding short and long-term debt obligations were $251.1 million, up from $250.8 million at January 31, 1999. At April 30, 1999, the Company's outstanding debt obligations consisted principally of the $250 million Notes. In addition to normal operating expenses, cash requirements are anticipated for financing anticipated growth, payment of outstanding debt obligations and the acquisition or licensing of products and technologies complementary to the Company's business. The Company believes that its existing cash, cash equivalents, short-term investments, available lines of credit and cash generated from operations, if any, will be sufficient to satisfy its currently anticipated cash requirements through April 30, 2000. However, the Company expects to make additional acquisitions and may need to raise additional capital through future debt or equity financing to the extent necessary to fund any such acquisitions. There can be no assurance that additional financing will be available, at all, or on terms favorable to the Company. Year 2000 Compliance BEA is aware of the issues associated with the programming code in existing computer systems as the Year 2000 approaches. The "Year 2000 problem" is pervasive and complex as virtually every computer operation will be affected in some way by the rollover of the two-digit year value to 00. The issue is whether computer systems will properly recognize date-sensitive information when the year changes to 2000. Systems that do not properly recognize such information could generate erroneous data or cause a system to fail. State of Readiness The Company has been evaluating the Year 2000 readiness of the most current versions of BEA M3, BEA TUXEDO and its other software products sold by the Company ("Products"). Internal information technology systems used in our operations ("IT Systems") and our non-IT Systems, such as security systems, building equipment, voice mail and other systems are being evaluated for Year 2000 readiness. The Company's evaluation primarily covers: identification of all Products, IT Systems, and non-IT Systems; assessing business and customer satisfaction risks associated with such systems, creating action plans to address known risks, executing and monitoring action plans, and contingency planning. The Company has completed the evaluation of the following products and believes the current versions of these products are Year 2000 compliant: 12 . BEA WebLogic Enterprise . BEA WebLogic Express . BEA WebLogic Server . BEA TUXEDO . BEA Manager . BEA Builder . BEA Jolt . BEA ObjectBroker . BEA ObjectBroker Desktop Connection . BEA MQ Series Connection . BEA Connect . BEA TOP END . BEA TOP END LU6.2 IBM Connectivity Some customers may be using software versions that are not Year 2000 compliant. The Company has been encouraging such customers to upgrade to current product versions. The Company has substantially tested BEA TOP END Security Services and confirmed its Year 2000 compliance, with exception of its porting to the HP UX platform, of which testing is expected to be completed in the second quarter of calendar year 1999. With respect to internal IT Systems and non-IT Systems, the Company has initiated an assessment of its internal IT Systems including third-party software and hardware technology and its non-IT Systems. The Company expects to substantially complete the testing in the second quarter of fiscal year ending January 31, 2000. To the extent that the Company is not able to test the technology provided by third-party vendors, the Company is seeking assurance from such vendors that their systems are Year 2000 compliant. The Company has been informed by substantially all of its business application software suppliers that their software is, or shortly will be, Year 2000 compliant. The software from these suppliers, such as PeopleSoft, Clarify and Microsoft, is used in the Company's financial, sales, customer support and administrative operations. Further, the Company relies, both domestically and internationally, upon various vendors, governmental agencies, utility companies, telecommunications service companies, delivery service companies and other service providers who are outside of the Company's control. There is no assurance that such parties will not suffer a Year 2000 business disruption, which could have a material adverse effect on the Company's financial condition and results of operations. Costs Associated with Year 2000 Issues To date, the Company has not incurred any material costs in connection with identifying or evaluating Year 2000 compliance issues. Most of its expenses have related to the opportunity cost of time spent by employees of the Company evaluating its software, the current versions of its products, and Year 2000 compliance matters. It is possible that the Company may experience additional costs associated with assisting customers with upgrades, but such costs are not expected by the management to be material. Risks of Year 2000 Issues Although the Company does not believe that it will incur any material costs or experience material disruptions in its business associated with preparing its internal systems for the Year 2000, there can be no assurances that the Company will not experience serious unanticipated negative consequences and/or material costs caused by undetected errors or defects in the technology used in its internal systems. Internal systems are primarily composed of third-party software and third-party hardware which contain embedded software and the Company's own software products. Worst case scenarios would include: corruption of data contained in the Company's internal information systems, hardware failure, and the failure of services provided by government agencies and other third 13 parties (e.g., electricity, phone service, water transport, Internet services, etc.). See "--Factors That May Impact Future Operating Results -Risks of Software Defects". Contingency Plans The Company has not fully developed a comprehensive contingency plan to address situations that may result from the Year 2000. If Year 2000 compliance issues are discovered, the Company will evaluate the need for contingency plans relating to such issues. Factors That May Impact Future Operating Results BEA Systems, Inc. operates in a rapidly changing environment that involves numerous risks and uncertainties. The following section lists some, but not all, of these risks and uncertainties which may have a material adverse effect on the Company's business, financial condition or results of operations. Limited Operating History; Integration of Acquisitions; No Assurance of Profitability BEA was incorporated in January 1995 and therefore has a limited operating history. We have generated revenues to date primarily from sales of BEA TUXEDO, a software product to which we acquired worldwide distribution rights in February 1996, and from fees for related software products and services. We have also acquired a number of businesses, technologies and products, most recently WebLogic, Inc. ("WebLogic"). Our limited operating history and the difficulties of integrating a number of separate and independent business operations subject our business to numerous risks. At April 30, 1999, we had an accumulated deficit of approximately $187.1 million. In addition, in connection with certain acquisitions completed prior to April 30, 1999, we recorded approximately $234.2 million as intangible assets. Under Generally Accepted Accounting Principles, these intangible assets are required to be amortized in future periods. Approximately $183.1 million of these assets have been amortized as of April 30, 1999 and we expect to amortize the remaining approximately $51.1 million in future periods through our fiscal year ending January 31, 2004. We expect to amortize $23.0 million of such intangible assets over the remaining quarters of fiscal year ending January 31, 2000 and $25.1 million in the fiscal year ended January 31, 2001. If we acquire additional businesses, products and technologies in the future, we may report additional, potentially significant, expenses related thereto. If future events cause the impairment of any intangible assets acquired in our past or future acquisitions, we may have to write off expenses sooner than we expect. Because of BEA's limited operating history and its ongoing write offs associated with prior acquisitions, there can be no assurance that we will be profitable in any future period and recent operating results should not be considered indicative of future financial performance. Potential Fluctuations in Quarterly Operating Results We expect to experience significant fluctuations in our future quarterly revenues and operating results as a result of many factors, including: . a widely-predicted freeze in deployment of new computer systems by large corporations in the second half of calendar year 1999, related to remediation of the Y2K problem . the size and timing of customer orders, introduction or enhancement of our products or our competitors' products . general economic conditions which can affect our customers' capital investment levels and the length of our sales cycle . the impact and duration of deteriorating economic and political conditions in Asia and related declines in Asian currency values . market acceptance of middleware products . the lengthy sales cycle for our products . technological changes in computer systems and environments . the structure, timing and integration of acquisitions of businesses, products and technologies 14 . whether we are able to develop, introduce and market new products on a timely basis . changes in our competitors' product offerings and pricing policies, and customer order deferrals in anticipation of future new products and product enhancements from BEA or competitors . whether we are able to expand our sales and marketing programs . the mix of our products and services sold and mix of distribution channels . whether we are able to meet our customers' service requirements . costs associated with acquisitions, including the acquisition of the TOP END enterprise middleware technology and product family from NCR, and the WebLogic acquisition . the terms and timing of financing activities . loss of key personnel . fluctuations in foreign currency exchange rates . interpretations of the recently-introduced accounting pronouncements on software revenues recognition. Industry sources widely predict that many large corporations will stop deploying new computer systems in late 1999 and early 2000, in order to avoid disrupting their computer systems before the year 2000. Large corporations represent the majority of BEA's customer base, and a material portion of our license fees come from new computer system deployments. BEA is monitoring its customer base, especially customers expected to place orders in late 1999, to determine their plans and have been informed by some of our customers that they intend to freeze. BEA is also taking several management steps to reduce our exposure to a freeze in deployments, such as providing special incentives to our sales force during this time and focusing on transactions that are not dependent on new deployments of pending projects. However, if the freeze in deployments is larger than we anticipate, starts earlier or lasts longer than we anticipate, or affects our targeted customers to a greater degree than we anticipate, our revenues in late 1999 or early 2000 could be materially lower than expected. Furthermore, certain of our customers who intend to freeze deployments in late 1999 have informed us that they intend to accelerate their deployments. This could result in an unusual fluctuation of orders, in which an unusually large number of orders are received in the middle of 1999, then an unusual decrease in orders in subsequent quarters. Customer behavior, and consequently our orders, during this period will be unusually difficult to forecast. As a result of all of these factors, we believe that quarterly revenues and operating results are difficult to forecast and period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of trends or future performance. Our revenues are derived principally from large orders as customers deploy our products throughout their organizations. Increases in the dollar size of individual license transactions also increase the risk of fluctuation in future quarterly results. If we cannot generate large customer orders, or customers delay or cancel such orders in a particular quarter, it will have a material adverse effect on our revenues and, more significantly on a percentage basis, our net income or loss in that quarter. Moreover, we typically receive and fulfill a majority of our orders within the quarter, with the substantial majority of our orders received in the last month of each fiscal quarter. As a result, we may not learn of revenues shortfalls until late in a fiscal quarter, after it is too late to adjust expenses for that quarter. Additionally, our operating expenses are based in part on our expectations for future revenues and are relatively fixed in the short term. Any revenue shortfall below our expectations could have an immediate and significant adverse effect on our results of operations. Similarly, shortfalls in our revenues and earnings from levels expected by securities analysts, or decreases in revenue or earnings projections by securities analysts could have an immediate and significant adverse effect on the trading price of our Common Stock. Moreover, our stock price is subject to the volatility generally associated with software and technology stocks and may also be affected by broader market trends unrelated to our performance. 15 Risks Associated with Past and Future Acquisitions From our inception in January 1995, we have made a number of strategic acquisitions. Integration of acquired companies, divisions and products involves the assimilation of potentially conflicting operations and products, which divert the attention of our management team and may have a material adverse effect on our operating results in future quarters. We acquired Leader Group, Inc. ("Leader") and a business unit of Penta Systems Technology, Inc. ("Penta") in the quarter ended April 30, 1998, TOP END in June 1998, the Entersoft Systems Corporation ("Entersoft") in July 1998, WebLogic, Inc. ("WebLogic") in September 1998 and Component Systems, LLC in May 1999. We intend to make additional acquisitions in the future, although there can be no assurance that suitable companies, divisions or products will be available for acquisition. Such acquisitions entail numerous risks, including the risk we will not successfully assimilate the acquired operations and products, or retain key employees of the acquired operations. 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 the acquired entities have established. In addition, if we undertake future acquisitions, we may issue dilutive securities, assume or incur additional debt obligations, incur large one-time expenses, 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. Recently, the Financial Accounting Standards Board ("FASB") voted to eliminate pooling of interests accounting for acquisitions and voted to eliminate the immediate write-off of acquired in-process research and development. The effect of these changes would be to increase the portion of the purchase price for any future acquisitions that must be charged to the Company's cost of revenues and operating expenses in the periods following any such acquisitions. As a consequence, the Company's results of operations in periods following any such acquisitions could be materially decreased. Although these changes would not directly affect the purchase price for any such acquisitions, they would have the effect of increasing the reported expenses associated with any such acquisitions. To that extent, these changes may make it more difficult for the Company to acquire other companies, product lines or technologies. Product Concentration We currently derive the majority of our license and service revenues from BEA TUXEDO and from related products and services. Although we expect these products and services to continue to account for the majority of our revenues in the immediate future, we believe that BEA WebLogic will become an increasingly important revenue source. As a result, factors adversely affecting the pricing of or demand for BEA TUXEDO and BEA WebLogic, such as competition, product performance or technological change, could have a material adverse effect on our business and consolidated results of operations and financial condition. Lengthy Sales Cycle Our customers typically use our products to integrate large, sophisticated applications that are critical to their business, and their purchases are often part of their implementation of a distributed computing environment. Customers evaluating our software products face complex decisions regarding alternative approaches to the integration of enterprise applications, competitive product offerings, rapidly changing software technologies and limited internal resources due to other information systems requirements. For these and other reasons, the sales cycle for our products is lengthy and is subject to delays or cancellation over which we have little or no control. Recently, we have experienced a significant increase in the number of million and multi-million dollar license transactions. In some cases, this has resulted in more extended customer evaluation and procurement processes, which in turn have lengthened the overall sales cycle for our products. Moreover, in contrast, during the second half of fiscal 1999, an increasing number of BEA customers began negotiating licenses to use BEA's enterprise application solutions as an architectural platform for several applications. These architectural commitments are larger in scope and potential revenue than single application transactions. In some cases, these architectural commitments also have longer sales cycles than BEA's typical single application transactions, because of both the customer's decision cycle in adopting an architectural platform and heightened corporate approval requirements for larger contracts. We believe general economic conditions that impact customers' capital investment decisions also affect our sales cycles. In addition, industry sources widely predict that large corporations will stop deploying new computer systems in late 1999 and early 2000, in order to avoid disrupting their computer systems before the year 2000. If our customers stop deploying new computer systems, our revenues could be materially reduced and our operating results could be materially adversely affected, especially in the third and fourth quarters of calendar year 16 1999 (our fiscal year 2000). Any significant change in customer buying decisions or sales cycles for our products could have a material adverse effect on our business, results of operations and financial condition. Although we use a standard license agreement which meets the revenue recognition criteria under current generally accepted accounting principles, we must often negotiate and revise terms and conditions of this standard agreement, 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. In addition, while we do not expect the recently issued Statement of Position 97-2, Software Revenues Recognition, ("SOP 97-2") and SOP 98-4 and SOP 98-9, which amend certain provisions of SOP 97-2, to have a material impact on our revenues and earnings, however, detailed implementation guidelines of the new standard have not yet been issued. Once issued, such detailed guidance could lead to unanticipated changes in our current revenues recognition practices and such changes could have an adverse impact on revenues and earnings. Competition The market for middleware, Web application servers and related services is highly competitive. Our competitors are diverse and offer a variety of solutions directed at various segments of the middleware and application server marketplace. These competitors include operating system vendors such as IBM, Sun Microsystems and database vendors such as Oracle. Microsoft has released a product that includes certain basic application server functionality and has announced that it intends to include middleware functionality in future versions of its Windows 2000 operating system. In addition, there are companies offering and developing middleware and application integration software products and related services that directly compete with products we offer, such as New Era of Networks. Further, software development tool vendors typically emphasize the broad versatility of their toolsets and, in some cases, offer complementary middleware software that supports these tools and performs basic middleware functions. Last, internal development groups within prospective customers' organizations may develop software and hardware systems that may substitute for those we offer. A number of our competitors and potential competitors have longer operating histories, significantly greater financial, technical, marketing and other resources, greater name recognition and a larger installed base of customers than us. Our principal competitors currently include hardware vendors who bundle their own middleware software products with their computer systems and database vendors that advocate client/server networks driven by the database server. IBM and Sun Microsystems are the primary hardware vendors who offer a line of middleware and application server solutions for its customers. IBM's sale of middleware and application server functionality along with its IBM proprietary hardware and application server systems requires us to compete with IBM in its installed base, where IBM has certain inherent advantages due to its significantly greater financial, technical, marketing and other resources, greater name recognition and the integration of its enterprise middleware functionality with its proprietary hardware and database systems. We need to differentiate our products based on functionality, interoperability with non-IBM systems, performance and reliability, and establish our products as more effective solutions to customers' needs. Oracle is the primary relational database vendor offering products that are intended to serve as alternatives to our enterprise middleware solutions. Microsoft has announced that it intends to include certain middleware functionality in future versions of its Windows 2000 operating system. Microsoft has also introduced a product that includes certain basic application server functionality. The bundling of competing functionality in versions of Windows requires us to compete with Microsoft in the Windows marketplace, where Microsoft has certain inherent advantages due to its significantly greater financial, technical, marketing and other resources, its greater name recognition, its substantial installed base and the integration of its middleware functionality with Windows. We need to differentiate our products from Microsoft's based on scalability, functionality, interoperability with non- Microsoft platforms, performance and reliability, and need to establish our products as more effective solutions to customers' needs. There can be no assurance that we will be able to successfully differentiate our products from those offered by Microsoft, or that Microsoft's entry into the middleware market will not materially adversely affect our business, operating results and financial condition. 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 our current and prospective customers. Accordingly, it is possible that new competitors or alliances among 17 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 could require us to reduce the price of our products and related services, which could materially adversely affect our business, operating results and financial condition. There can be no assurance that we will be able to compete successfully against current and future competitors and the failure to do so would have a material adverse effect upon our business, operating results and financial condition. Dependence on Proprietary Technology; Risk of Infringement 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. No assurance can be given that other companies will not successfully challenge the validity or scope of our patents or that our patents will 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 this 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. Effective protection of intellectual property rights is unavailable or limited in certain foreign countries. There can be no assurance that the protection of our proprietary rights will be adequate or that our competitors will not independently develop similar technology, duplicate our products or design around any patents or other intellectual property rights we hold. We do not believe that any of our products infringe the proprietary rights of third parties. There can be no assurance, however, that third parties will not claim the Company's current or future products infringe their rights. Any such claims, with or without merit, could cause costly litigation that could absorb significant management time, which could materially adversely effect our business, operating results and financial condition. Such claims might require us to enter into royalty or license agreements. If required, the Company 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 the Company's business, operating results and financial condition. In particular, BEA has been named in a lawsuit by RSA Data Security ("RSA") claiming that BEA has improperly distributed RSA products and infringed RSA's patents. BEA is investigating this claim and currently believes that it has rights to distribute RSA's products under our TUXEDO distribution agreement with Novell, is entitled to indemnification from Novell for such claim and will not have material liability for such claim. However, there can be no assurance that such claim will not result in a material payment by BEA or diversion of BEA management time and attention. International Operations International revenues accounted for 41 percent and 53 percent of our consolidated revenues for the three months ended April 30, 1999 and 1998, respectively. We sell our products and services through a network of branches and subsidiaries located in 24 countries worldwide. In addition, we also market through distributors in Europe and the Asia/Pacific region. We believe that our success depends upon continued expansion of our international operations. Our international business is subject to a number of risks, including unexpected changes in regulatory practices and tariffs, greater difficulties in staffing and managing foreign operations, longer collection cycles, seasonality, potential changes in tax laws, greater difficulty in protecting intellectual property and the impact of fluctuating exchange rates between the US dollar and foreign currencies in markets where BEA does business, in particular the French franc, the German mark, the British pound, the Japanese yen, the Australian dollar and the Korean won. General economic and political conditions in these foreign markets may also impact our international revenues. Since the late summer of 1997, a number of Pacific Rim countries have experienced economic, banking and currency difficulties that has led to economic downturns in those countries. Among other things, the decline in value of Asian currencies, together with difficulties obtaining credit, has resulted in a decline in the purchasing power of our Asian customers, which in turn has resulted in the delay of orders for our products from certain Asian 18 customers and is likely to result in further delays and, possibly the cancellation, of such orders. As a result of such delays, our revenues from Asia for the fiscal year ended April 30, 1999 comprised a lower percentage of total revenues than we have historically experienced. We anticipate that weak Asian conditions will continue to adversely impact our financial results. It is difficult for us to predict the extent of the future impact of these conditions. 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. Management of Growth We are continuing to experience a period of rapid and substantial growth that has placed, and if such growth continues would continue to place, a strain on the Company's administrative and operational infrastructure. We have increased the number of our employees from 120 employees in three offices in the United States at January 31, 1996 to over 1,200 employees in over 52 offices in 24 countries at April 30, 1999. Our ability to manage our staff and growth effectively requires us to continue to improve our operational, financial and management controls, reporting systems and procedures. In this regard, we are currently updating our management information systems to integrate financial and other reporting among our multiple domestic and foreign offices. In addition, we intend to continue to increase our staff worldwide and to continue to improve the financial reporting and controls for our global operations. There can be no assurance that we will be able to successfully implement improvements to our management information and control systems in an efficient or timely manner or that, during the course of this implementation, we will not discover deficiencies in existing systems and controls. If we are unable to manage growth effectively, our business, results of operations and financial condition will be materially adversely affected. Dependence on Growth of Market for Middleware and Web Application Servers We sell our products and services in the middleware and Web application server markets. These markets are emerging and 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 a presence on the Web for commerce, and developers of web-based commerce applications. Our future financial performance will depend in large part on 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 middleware technology. There can be no assurance that the markets for middleware technology and Web application servers and related services will continue to grow. If these markets fail to grow or grow more slowly than we currently anticipate, or if we experience increased competition in these markets, our business, results of operations and financial condition will be adversely affected. Year 2000 Risks There can be no assurances that the Company's current products do not contain undetected errors or defects associated with year 2000 date functions that may result in material costs or liabilities to the Company. Moreover, our software directly and indirectly interacts with a large number of other hardware and software systems. Some of the Company's customers are running product versions that are not year 2000 compliant. The Company has been encouraging such customers to migrate to current product versions. We are unable to predict to what extent our business may be affected if our software or the systems that operate in conjunction with our software experience a material year 2000 related failure. Some commentators have stated that a significant amount of litigation will arise out of year 2000 compliance issues, and the Company is aware of a growing number of lawsuits against other software vendors. Because of the unprecedented nature of such litigation, it is uncertain whether or to what extent the Company may be affected by it. The Company could also experience serious unanticipated negative consequences and/or material costs caused by undetected errors or defects in the technology used in its internal systems. Internal systems are primarily composed of third-party software and third-party hardware which contain embedded software and the Company's own software products. Worst case scenarios would include: corruption of data contained in the Company's internal information systems, hardware failure, and the failure of services provided by government agencies and other third parties (e.g., electricity, phone service, water transport, Internet services, etc.). 19 In addition, a widely-predicted freeze in deployment of new computer systems by large corporations in the second half of fiscal year 2000 related to remediation of the Y2K problem could result in an unusual fluctuation of orders, in which an unusually large number of orders are received in the middle of 2000, followed by an unusual decrease in orders in subsequent quarters. Dependence on Key Personnel and Need to Hire Additional Personnel We believe our future success will depend upon our ability to attract and retain highly skilled personnel including the Company's founders, Messrs. William T. Coleman III, Edward W. Scott, Jr., Alfred S. Chuang and key members of management. Competition for these types of employees is intense, and there can be no assurance that we will be able to retain our key employees or that we will be successful in attracting, assimilating and retaining qualified candidates in the future. As we seek to expand our global organization, the hiring of qualified sales, technical and support personnel will 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. Expanding Distribution Channels and Reliance on Third Parties To date, we have sold our products principally through our direct sales force, as well as through indirect sales channels, such as system platform companies, packaged application software developers, systems integrators and independent consultants, independent software tool vendors and distributors. Our ability to achieve revenue growth in the future will depend in large part on our success in expanding our direct sales force and in further establishing and expanding relationships with distributors, ISVs, OEMs and systems integrators. In particular, a significant part of our strategy is to embed our technology in products our ISV customers offer. We intend to seek distribution arrangements with additional ISVs to embed our middleware and Web application servers technology in their products. There can be no assurance that we will be able to successfully expand our direct sales force or other distribution channels, secure license agreements with additional ISVs on commercially reasonable terms or at all, or otherwise further develop our relationships with indirect distribution channels. There also can be no assurance that any such expansion or additional license agreements would increase our revenues. Although we believe that our investments in the expansion of our direct sales force and in the establishment of other distribution channels through third parties ultimately will improve our operating results, to the extent that such investments are made and revenues do not correspondingly increase, our business, results of operations and financial condition will be materially and adversely affected. We rely on informal relationships with a number of consulting and systems integration 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 sale process. We will need to expand our relationships with third parties in order to support license revenues growth. Many such firms have similar, and often more established, relationships with our principal competitors. There can be no assurance that these and other third parties will provide the level and quality of service required to meet the needs of our customers, that we will be able to maintain an effective, long term relationship with these third parties, or that these third parties will continue to meet the needs of our customers. Rapid Technology Change; Dependence on New Products and Product Enhancements The market for our products is highly fragmented, competitive with alternative computing architectures, and characterized by continuing technological development, evolving 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 render our existing products obsolete and unmarketable. As a result, our success depends upon our ability to enhance existing products, respond to changing customer requirements and develop and introduce in a timely manner new products that keep pace with technological developments and emerging industry standards. There can be no assurance that our products will adequately address the changing needs of the marketplace or that we will be successful in developing and marketing enhancements to our existing products or products incorporating new technology on a timely basis. Failure to develop and introduce new products, or enhancements to existing products, in a timely manner in response to changing market conditions or 20 customer requirements, will materially and adversely affect the Company's business, results of operations and financial condition. Risk of Software Defects The software products we offer are internally complex and, despite extensive testing and quality control, may contain errors or defects, especially when we first introduced them. We may need to issue corrective releases of our software products to fix these defects or errors. These defects and errors could also cause damage to our reputation, loss of revenues, product returns or order cancellations, or lack of market acceptance of our products. Accordingly, these defects and 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 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 due to the Year 2000 problem 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 BEA's software is not at fault, BEA could suffer material expense and material diversion of management time in defending any such lawsuits. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Year 2000 Compliance". Control by Management and Current Stockholders As of March 31, 1999, BEA's officers and directors and their affiliates, in the aggregate, had voting control over approximately 58.8 percent of BEA's voting Common Stock. In particular, Warburg, Pincus Ventures, L.P. ("Warburg") had effective voting control over approximately 49.0 percent of BEA's voting Common Stock and beneficially owned approximately 54.7 percent of BEA's Common Stock (which includes the non-voting Class B Common Stock owned by Warburg). As a result, these stockholders would be able to control all matters requiring majority stockholder approval, including the election of directors and approval of significant corporate transactions. The voting power of Warburg combined with BEA's officers and directors under certain circumstances could have the effect of delaying, or preventing a change in control of BEA. Significant Leverage; Debt Service In connection with our sale of 4% Convertible Subordinated Notes in June and July 1998, we incurred $250 million in long-term indebtedness. Our principal and interest payment obligations increased substantially because of this indebtedness. The degree to which we are leveraged could materially and adversely affect our ability to obtain financing for working capital, acquisitions or other purposes and could make us more vulnerable to industry downturns and competitive pressures. These notes are convertible into Common Stock, which conversion could cause substantial dilution to stockholders and would increase the number of shares eligible for sale in the market, but would eliminate the need for the Company to repay the principal amount of such converted notes. There can be no assurance, however, that any of these notes will be converted. Our ability to meet our debt service obligations will be dependent upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control. We will require substantial amounts of cash to fund scheduled payments of interest on these notes, payment of the principal amount of these notes at maturity, payment of principal and interest on our other indebtedness, future capital expenditures and any increased working capital requirements. If we cannot meet our cash requirements out of cash flow from operations, there can be no assurance that we will be able to obtain alternative financing. If we 21 cannot obtain such financing, our ability to respond to changing business and economic conditions, to make future acquisitions, to absorb adverse operating results or to fund capital expenditures or increased working capital requirements may be adversely affected. Any failure by us to satisfy our obligations with respect to these notes at maturity (with respect to payments of principal) or prior thereto (with respect to payments of interest or required repurchases) would constitute a default under the indenture entered into in connection with the issuance of these notes and could cause a default under agreements governing other indebtedness, if any, of BEA. Possible Adverse Impact of Recent Accounting Pronouncements The American Institute of Certified Public Accountants has issued a series of recent pronouncements which address revenue recognition in the software industry, including SOP 97-2, SOP 98-4, and SOP 98-9. These pronouncements principally focus on concepts versus specific implementation guidance. The Company believes it is in compliance with these standards, but the software industry and the accounting profession are currently discussing a wide range of potential interpretations which may result in the issuance of more pronouncements or interpretive guidance. As future guidance becomes available or if the software industry broadly adopts certain practices which are different than the Company's current revenue recognition practices which could have a material adverse effect on our business practices, financial condition, or results of operations. The Company has not fully assessed its ability to comply with SOP 98-9 using current business practices. However, the Company believes that SOP 98-9 may require significantly more revenues to be deferred for certain types of transactions. 22 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Foreign Exchange BEA's revenue originating outside the United States was 41 percent and 53 percent of total revenues for the three months ended April 30, 1999 and 1998, respectively. For the three months ended April 30, 1999 international revenues from EMEA and APAC represented 33 percent and 7 percent of total revenues. Within EMEA, France represented 11 percent of total revenues for the three months ended April 30, 1999. International sales are made mostly from the Company's foreign sales subsidiaries in the local countries and are typically denominated in the local currency of each country. These subsidiaries also incur most of their expenses in the local currency. Accordingly, foreign subsidiaries use the local currency as their functional currency. The Company's international business is subject to risks typical of an international business, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange volatility. Accordingly, the Company's future results could be materially adversely impacted by changes in these or other factors. The Company's exposure to foreign exchange rate fluctuations arise in part from intercompany accounts in which certain costs of software development, support and product marketing incurred in the United States are charged to the Company's foreign subsidiaries. These intercompany accounts are typically denominated in the functional currency of the foreign subsidiary in order to centralize foreign exchange risk with the parent company in the United States. The Company is also exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into U.S. dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact overall financial results. The Company has a program to reduce the effect of foreign exchange transaction gains and losses from recorded foreign currency-denominated assets and liabilities. This program involves the use of forward foreign exchange contracts in certain European and Asian currencies, principally U.K., France, Germany, Finland, Sweden, Japan and Australia. A forward foreign exchange contract obligates the Company 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. Each month the Company marks to market the foreign exchange contracts based on the change in the foreign exchange rates with any resulting gain or losses recorded in the interest and other expenses. The Company does not currently hedge anticipated foreign currency- denominated revenues and expenses not yet incurred. Interest Rates The Company invests its cash in a variety of financial instruments, consisting principally of investments in commercial paper, interest-bearing demand deposit accounts with financial institutions, money market funds and highly liquid debt securities of corporations, municipalities and the U.S. Government. These investments are denominated in U.S. dollars. Cash balances in foreign currencies overseas are operating balances and are only invested in short-term time deposits of the local operating bank. The Company accounts for its investment instruments in accordance with Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, ("FAS 115"). All of the cash equivalent, short term and long term investments are treated as "available-for- sale" under FAS 115. Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, the Company's future investment income may fall short of expectations due to changes in interest rates or the Company may suffer losses in principal if forced to sell securities which have seen a decline in market value due to changes in interest rates. However, the Company reduces its interest rate risk by investing its cash in instruments with short maturities. At April 30, 1999 the average maturity of the Company's cash equivalents and investments was 17 days. 23 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits The following exhibits are filed by attachment to this Form 10-Q: Exhibit Description ------- ----------- 27.1 Financial Data Schedule (b) Reports on Form 8-K No reports on Form 8-K were filed by the Company during the fiscal quarter ended April 30, 1999. 24 SIGNATURES Pursuant to the requirement of the Security Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. BEA SYSTEMS, INC. (Registrant) /s/ STEVE L. BROWN ------------------ Steve L. Brown Executive Vice President and Chief Financial Officer (Principal Financial and Chief Accounting Officer) Dated: June 14, 1999 25