THE FRONT OFFICE GORILLA GAME: Q4, 2002 -- Part 1
The News
Microsoft released its CRM sales and service modules in January. Intended for small and medium-size businesses, it is available in two editions. The Standard Edition will be distributed through Ingram Micro and its reselling partners. The more robust Professional Suite Edition will be sold by certified resellers in partnership with Microsoft's Business Solutions division. The price of the basic version is $400 per user plus $1000 for the server. The beefed up version costs $1300 for the user plus $2000 for the server. To put those prices in context, the average selling price per user of Siebel's CRM software is about $2000.
In the previous quarter I mentioned that a public pension fund has sued Tom Siebel and its directors for issuing stock options since 1999 to Siebel that violated the company's rules. Just hours before this week's conference call abaout the company's performance in Q4, Siebel Systems got out the PR that Tom Siebel has returned the options granted to him during the last four years. (More about this below.) Though nothing about this has to do with any of the rules of Gorilla Gaming, it's nonetheless important to investors.
Conference Call Overview
The company is apparently in a mode of preparing pdf files to be reviewed along with conversation that takes place during the conference call. That file, chock full of information, can be accessed at siebel.com
Income Statement
Total Revenue: down 19% year over year; up 11% from Q3
Licensing Revenue: down 37% year over year; up 24% from Q3
Service Revenue: virtually the same year over year; up 3% from Q3
Pro forma EPS: down 64% year over year; up 67% from Q3.
EPS: net loss of $.08 compared to a profit of $.11 last year; net loss 58% smaller than in Q3.
Free cash flow
QUARTERLY
Operating cash flow less ESOP tax benefits less capex:
down 11% year over year; up 60% from Q3.
The same calculation on a per-share basis:
down 3% year over year; up 58% from Q3.
Free cash flow for every dollar of revenue: $.22
Up 10% year over year; up 33% from Q3.
ANNUALLY
Each of the last three years were record years for producing free cash flow and free cash flow per share. Free cash flow in 2002 was up 26% from 2001. On a per-share basis, it was up 38%. Free cash flow for every dollar of revenue in 2002 was $.22, up 57% from the previous year.
CAPEX is a large component that affects free cash flow. In 2001 CAPEX was 12% of revenue, the highest since 1996 when the company was relatively in the incubator stage. Just the opposite in 2002, CAPEX fell to 4% of revenue, the lowest of the last seven years. To generate such high free cash flow for each dollar of sales ($0.22 in 2002), it will probably be important to constrain growth of CAPEX. The CFO said that in 2003 the company will continue "not buying equipment."
Operating Margin
The operating loss in Q4 was $67 million, down from the $155 million loss in Q3. The operating profit a year earlier was $95 million, 19% of revenue.
The pro forma operating profit in Q4 was $29 million, 7% of revenue. A year earlier it was $95 million, 19% of revenue.
The pro forma operating profit in 2002 was $166 million, 10% of revenue. In 2001 it was $358 million, 17% of revenue.
Market Share
For the last several years, management reported estimated quarterly market share of licensing revenue generated by the top four or five competitors in each of nine product niches. Surprisingly, management didn't produce those estimates this quarter. When an analyst asked for the numbers, some very vague generalizations were given but no specifics were produced. Tom Siebel mentioned that the numbers weren't available because their sources of information weren't reliable. Yet one of his officers mentioned that market share was maintained or increased in every category. That seemed highly contradictory to me and gave me the distinct impression that Tom Siebel might have been beating around the bush. My criticism results from my feeling that the company tends to present data in the most positive light rather than consistently reporting data in the same manner and letting the warts show. (Most recent example: The press release for Q4 highlighted that revenue and net income was higher than in Q3 but failed to mention that both were worse compared to the year-earlier period.)
It was stressed in the conference call and provided in the pdf file that internal, custom CRM apps represent the vast, vast majority of the CRM market. The packaged CRM market was estimated to be $3.7 billion in 2002. Including the custom-built apps, the market was estimated to be $21 billion. Siebel management sees the custom-built segment has a huge market opportunity for their packaged apps.
Miscellaneous Numbers
DSO decreased to a record low of 63 days from 72 days in Q2. Management continues to maintain a target of 75 - 85 days. Payment terms decreased to 28 days from 34 days.
Domestic Licensing: 51% of total licensing, down from 52% in Q3.
International Licensing: 49% of total licensing, up from 48% in Q3.
Regarding verticals, there is vital information in the pdf file mentioned above.
Excluding the really huge deals, the average cost of Siebel's CRM software per user in 2000, 2001 and 2002 was $2300, $2100 and $1900, respectively.
Transaction Size
The average transaction was $403,000, compared to $305,000 in Q3. Excluding transactions less than $50,000, the average size was $654,000, compared to $565,000 in Q3.
I understood the CFO to say Siebel closed 38 deals over $1 million and the CEO to say there were 32 deals. The slide in the pdf file says 33 deals were closed. 24 deals of that size were reported in Q3.
There were 5 transactions in excess of $5 million, up from 3 in Q3. It became apparent that one of them was a huge ATT Business Services transaction lost last year to Oracle. Apparently ATT decided to replace the Oracle software with Siebel's. I have no idea what the discount for such a large deal (22,000 users) would be. If it was a 20% discount from the average selling price, the licensing revenue was in the range of $35 million. MY GUESS: Had the ATT deal not closed, Q4 revenue would not have been higher than Q3.
For the second quarter in a row, there were no concurrent transactions. (In the recent past, concurrent transactions of all software companies have come under scrutiny as a way of increasing revenue when the customers really didn't want product in the first place.)
Competitive Landscape
The numbers shown below provide the percentage of transactions in which top competitors' products were evaluated:
Year Oracle PeopleSoft/Vantive SAP
2000 8% 7% 5%
2001 7% 4% 4%
2002 5% 6% 6%
In about 11% of the transactions, the option to build a custom app internally is evaluated. That's a correction of last quarter's information that it was 47%. Even so, the point was stressed that home-grown CRM apps offer far more competition than competitors' packaged apps. That's consistent with the above info about market share that the custom apps own the lion's share of the total market.
Siebel replaced Oracle software at ATT and Lexmark. PeopleSoft product was replaced at Novel and Client Logic. SAP's software was replaced at Unilever and Gillette.
ERM
There are now 230 ERM customers, not hugely different from the previous quarter. Siebel has been selling ERM software since April, 2001. That year sales was $25 million. In 2002 sales was $90 million, up 260%. You get do decide if the huge increase is indicative of crossing the chasm or a tornado in progress. Considering the massive market opportunity, I'm leaning toward the former. But I really don't have a strong opinion, much less an informed one.
Analytics Software
Sales in 2001 was a little less than $50 million. It grew 231% in 2002 to $157 million. Again, a sign of crossing the chasm or a tornado?
Universal Applications Network (UAN)
Announced in Q2, UAN is now shipping in support of 7 basic apps and 75 customers were added to the list in Q4. Pricing is $35,000 per integration and $10,000 for each additional attachment. Initial configurations are sometimes bought for as little as 10 or fewer attachments but it's important to remember that General Motors, as an example of a huge company, has 5000 apps which might require millions of attachments.
Though details about pricing were discussed for the first time (in response to an analyst's question), it was emphasized that pricing is not as important as savings generated by the product. The compelling selling points are that the price of a packaged web integration reduces total cost of custom-built software about 60% and that the time to get the product in use is reduced about one-third.
Siebel has a dedicated sales and marketing team for UAN. Accenture, IBM, KPMG, Cap Gemini and Deloitte are certified partners integrating the product.
Return of Stock Options
Tom Siebel was asked why he returned the stock options mentioned above. He put it in the context that management has always tried to align management interest with investor interest. In the go-go years of hypergrowth, stock options and bonuses were enjoyed by management. In the last two years, the executive management team took a 20% cut in pay and an elimination of bonuses. Siebel's salary each of those years was one dollar. He felt a return of his options granted in the previous four years was consistent with the belt-tightening of the rest of the management team. (Do you buy that explanation?)
Going Forward
Management stressed that the focus in the next few years will be in lowering the cost structure, increasing revenue and increasing margins. That contrasts with 2000 when they were focused on managing hypergrowth. In the comparatively difficult selling environment of 2001 and 2002, they were focused on maintaining or increasing market share while remaining cash-flow positive.
The company's internal goal is to grow licensing and total revenue 10% - 15% in 2003. However, guidance for analysts was a much more conservative 5% for both.
In my Q2 report, I surmised from statements in that conference call that management is targeting a 15% operating margin. That was confirmed in this conference call when management guided an operating margin of 12% - 15%.
I was surprised that the company issued guidance as far out as 2004 to include a 20% increase in licensing and total revenue and an expansion of the operating margin in a range of 22% to 24%.
Management feels the current approximate head count is sufficient to meet all of the above guidance. (Increasing revenue by that much without increasing the head count seems unlikely to me, but we'll wait and see what happens.)
Management expects to continue acquiring technology to expand its product line.
THE GORILLA GAME
Regarding the information reported regularly in this section, I will get to that later this weekend.
--Mike Buckley |
