UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________to _________
Commission file number 0-20725
SIEBEL SYSTEMS, INC. (Exact name of Registrant as specified in its charter)
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2207 Bridgepointe Parkway
San Mateo, CA 94404
(Address of principal executive offices, including zip code)
(650) 477-5000
(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 [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES [X] NO [ ]
The number of shares outstanding of the Registrant's common stock, par value $.001 per share, as of April 19, 2004, was 503,828,953.
SIEBEL SYSTEMS, INC.
FORM 10-Q
For the Quarterly Period Ended March 31, 2004
Table of Contents
| Part I. Financial Information |
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| Item 1. Financial Statements | |
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Consolidated Balance Sheets as of December 31, 2003 and March 31, 2004 |
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Consolidated Statements of Operations and Comprehensive Income for the three months ended March 31, 2003 and 2004 |
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Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and 2004 |
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| Notes to Consolidated Financial Statements |
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| Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations |
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| Item 3. Quantitative and Qualitative Disclosures About Market Risk |
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| Item 4. Controls and Procedures |
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Part II. Other Information
| Item 1. Legal Proceedings |
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| Item 6. Exhibits and Reports on Form 8-K |
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| Signatures |
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Part I. Financial Information
Item 1. Financial Statements
SIEBEL SYSTEMS, INC.
Consolidated Balance Sheets
(in thousands, except per share data; unaudited)
December 31, March 31,
2003 2004
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Assets
Current assets:
Cash and cash equivalents........................................... $ 583,532 $ 659,685
Short-term investments.............................................. 1,439,674 1,473,242
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Total cash, cash equivalents and short-term investments...... 2,023,206 2,132,927
Accounts receivable, net............................................ 259,834 231,097
Deferred income taxes............................................... 61,742 59,786
Prepaids and other.................................................. 52,186 38,637
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Total current assets......................................... 2,396,968 2,462,447
Property and equipment, net............................................ 157,391 131,016
Goodwill............................................................... 140,957 144,795
Intangible assets, net................................................. 10,786 11,576
Other assets........................................................... 48,892 47,060
Deferred income taxes.................................................. 95,866 94,866
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Total assets................................................. $ 2,850,860 $ 2,891,760
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Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable.................................................... $ 18,907 $ 13,570
Accrued expenses.................................................... 333,270 303,080
Restructuring obligations........................................... 53,676 46,346
Deferred revenue.................................................... 282,217 311,375
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Total current liabilities.................................... 688,070 674,371
Restructuring obligations, less current portion........................ 104,405 98,697
Other long-term liabilities............................................ 8,159 6,478
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Total liabilities............................................ 800,634 779,546
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Commitments and contingencies
Stockholders' equity:
Common stock; $0.001 par value; 2,000,000 shares authorized;
498,305 and 503,096 shares issued and outstanding, respectively... 498 503
Additional paid-in capital........................................... 1,550,834 1,581,725
Deferred compensation................................................ (1,479) (1,235)
Accumulated other comprehensive income............................... 58,650 57,846
Retained earnings.................................................... 441,723 473,375
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Total stockholders' equity................................... 2,050,226 2,112,214
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Total liabilities and stockholders' equity................... $ 2,850,860 $ 2,891,760
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See accompanying notes to consolidated financial statements.
SIEBEL SYSTEMS, INC.
Consolidated Statements of Operations and Comprehensive Income
(in thousands, except per share data; unaudited)
Three Months Ended
March 31,
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2003 2004
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Revenues:
Software.................................................... $ 112,092 $ 126,799
Professional services, maintenance and other................ 220,663 202,488
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Total revenues.......................................... 332,755 329,287
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Cost of revenues:
Software.................................................... 4,721 3,207
Professional services, maintenance and other................ 125,512 107,925
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Total cost of revenues.................................. 130,233 111,132
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Gross margin....................................... 202,522 218,155
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Operating expenses:
Product development......................................... 79,271 72,024
Sales and marketing......................................... 100,172 86,257
General and administrative.................................. 26,366 21,574
Restructuring and related expenses.......................... -- 598
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Total operating expenses................................ 205,809 180,453
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Operating income (loss)............................ (3,287) 37,702
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Other income, net:
Interest and other income, net.............................. 15,397 12,075
Interest expense............................................ (4,894) (320)
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Total other income, net................................. 10,503 11,755
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Income before income taxes......................... 7,216 49,457
Income taxes................................................... 2,598 17,805
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Net income......................................... $ 4,618 $ 31,652
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Diluted net income per share................................... $ 0.01 $ 0.06
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Basic net income per share..................................... $ 0.01 $ 0.06
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Shares used in diluted share computation....................... 511,391 546,401
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Shares used in basic share computation......................... 487,254 501,128
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Comprehensive income:
Net income..................................................... $ 4,618 $ 31,652
Other comprehensive income (loss), net of taxes:
Foreign currency translation adjustments.................... 5,316 (3,844)
Realized gain on marketable investments previously
recognized in other comprehensive income................. (1,547) (1,872)
Unrealized gain on investments, net......................... 2,422 4,912
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Other comprehensive income (loss)....................... 6,191 (804)
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Total comprehensive income......................... $ 10,809 $ 30,848
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See accompanying notes to consolidated financial statements.
SIEBEL SYSTEMS, INC.
Consolidated Statements of Cash Flows
(in thousands; unaudited)
Three Months Ended
March 31,
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2003 2004
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Cash flows from operating activities:
Net income.............................................................. $ 4,618 $ 31,652
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization........................................ 39,518 31,478
Amortization of identifiable intangible assets....................... 1,959 1,710
Compensation related to stock options, net........................... 505 195
Provision for doubtful accounts and sales returns.................... 3,779 (1,000)
Tax benefit from exercise of stock options........................... -- 1,500
Deferred income taxes................................................ 55 --
Write-down of cost-method investments to fair value.................. 253 1,083
Net realized gains on marketable investments......................... (1,547) (1,872)
Changes in operating assets and liabilities:
Accounts receivable............................................... 37,338 30,234
Prepaids and other................................................ 7,959 14,305
Accounts payable and accrued expenses............................. (30,249) (34,980)
Restructuring obligations......................................... (15,300) (13,641)
Deferred revenue.................................................. 13,923 29,135
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Net cash provided by operating activities....................... 62,811 89,799
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Cash flows from investing activities:
Purchases of property and equipment, net................................ (9,255) (225)
Purchases of short-term investments..................................... (531,759) (413,446)
Sales and maturities of short-term investments.......................... 475,808 382,507
Proceeds from sale of marketable equity securities...................... 126 --
Purchase consideration for acquired businesses, net of cash received.... (1,500) (4,821)
Other non-operating assets and non-marketable securities................ 1,332 4
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Net cash used in investing activities........................... (65,248) (35,981)
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Cash flows from financing activities:
Proceeds from issuance of common stock.................................. 5,266 29,379
Repayments of capital lease obligations................................. (3,256) (3,278)
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Net cash provided by financing activities....................... 2,010 26,101
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Effect of exchange rate fluctuations....................................... 5,304 (3,766)
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Change in cash and cash equivalents........................................ 4,877 76,153
Cash and cash equivalents, beginning of period............................. 667,511 583,532
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Cash and cash equivalents, end of period................................... $ 672,388 $ 659,685
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Supplemental disclosures of non-cash activities:
Fair value of common stock and stock options issued for acquisitions.... $ 1,670 $ --
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See accompanying notes to consolidated financial statements.
SIEBEL SYSTEMS, INC. Summary of Significant Accounting Policies
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Basis of Presentation
The accompanying unaudited consolidated financial statements include the accounts of Siebel Systems, Inc. and its wholly owned subsidiaries (the "Company"). The accompanying unaudited consolidated financial statements have been prepared on substantially the same basis as the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations regarding interim financial statements. All amounts included herein related to the consolidated financial statements as of March 31, 2004 and the three months ended March 31, 2003 and 2004 are unaudited. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2003.
In the opinion of management, these financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for their fair presentation. The interim results presented are not necessarily indicative of results for any subsequent quarter or for the year ending December 31, 2004. Certain prior year amounts have been reclassified to conform to the current year presentation.
Use of Estimates
The Company's consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires that the Company make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to revenue recognition, provision for doubtful accounts and sales returns, fair value of investments, fair value of acquired intangible assets and goodwill, useful lives of intangible assets and property and equipment, income taxes, restructuring obligations, and contingencies and litigation, among others. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ significantly from the estimates made by management with respect to these and other items that require management's estimates.
Stock-Based Compensation
The Company accounts for its employee stock-based compensation plans using the intrinsic value method, as prescribed by APB No. 25 "Accounting for Stock Issued to Employees" and interpretations thereof (collectively referred to as "APB 25"). Accordingly, the Company records deferred compensation costs related to its employee stock options when the current market price of the underlying stock exceeds the exercise price of each stock option on the date of grant. The Company records and measures deferred compensation for stock options granted to non-employees, other than members of the Company's Board of Directors, based on the fair value of the stock options. Deferred compensation is expensed on a straight-line basis over the vesting period of the related stock option. The Company did not grant any stock options at exercise prices below the fair market value of the Company's common stock on the date of grant during any period presented.
As of December 31, 2003 and March 31, 2004, the Company's deferred compensation balances primarily related to restricted stock awards issued in the fourth quarter of 2002 and the remaining unamortized portion of compensation expense associated with stock options granted by certain acquired companies and converted under the terms of the agreements between the Company and the companies acquired. The Company is amortizing the deferred compensation on a straight-line basis over the respective vesting periods, which is generally five years.
An alternative method to the intrinsic value method of accounting for stock-based compensation is the fair value approach prescribed by SFAS No. 123 "Accounting for Stock-Based Compensation," as amended by SFAS No. 148 "Accounting for Stock-Based Compensation - Transition and Disclosure" (collectively referred to as "SFAS 123"). If the Company followed the fair value approach, the Company would be required to record deferred compensation based on the fair value of the stock option at the date of grant. The fair value of the stock option is required to be computed using an option-pricing model, such as the Black-Scholes option valuation model, at the date of the stock option grant. The deferred compensation calculated under the fair value method would then be amortized over the respective vesting period of the stock option.
As required by SFAS 123, the Company has prepared a reconciliation of its earnings as reported on the statement of operations to the earnings that the Company would have reported if it had followed SFAS 123 in accounting for its stock-based compensation arrangements. For purposes of this reconciliation, the Company added back all stock-based employee compensation expense recorded in accordance with APB 25 in its statement of operations, then deducted the stock-based employee compensation expense determined under SFAS 123. Summarized below are the pro forma effects on net income and net income per share data, as if the Company had elected to use the fair value approach prescribed by SFAS 123 to account for its employee stock-based compensation plans (in thousands, except per share data):
Three Months Ended
March 31,
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2003 2004
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Net income (loss):
As reported.......................................................... $ 4,618 $ 31,652
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Compensation expense related to:
Stock options accounted for in accordance with APB 25.............. 505 195
In-the-money stock options......................................... (4,097) (4,503)
Stock purchase rights under the Purchase Plan...................... (863) (2,559)
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Total pro forma expense related to "in the money" stock
options and Purchase Plan..................................... (4,455) (6,867)
Out-of-the-money stock options..................................... (42,170) (40,276)
Stock options cancelled for no consideration....................... (251,821) --
Stock options forfeited/cancelled in connection with terminations.. (9,166) --
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Total pro forma expense giving effect to SFAS 123............... (307,612) (47,143)
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Pro forma giving effect to SFAS 123.................................. $ (302,994) $ (15,491)
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Diluted net income (loss) per share:
As reported.......................................................... $ 0.01 $ 0.06
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Pro forma giving effect to SFAS 123.................................. $ (0.62) $ (0.03)
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Basic net income (loss) per share:
As reported.......................................................... $ 0.01 $ 0.06
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Pro forma giving effect to SFAS 123.................................. $ (0.62) $ (0.03)
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Consistent with the Company's accounting for deferred tax assets resulting from the exercise of employee stock options in the accompanying consolidated financial statements, the Company has not provided a tax benefit on the pro forma expense in the above table.
In-the-money stock options in the above table have exercise prices below the closing price of the Company's common stock as of the end of each of the respective periods, and out-of-the-money stock options have exercise prices equal to or greater than the closing price of the Company's common stock as of the end of each of the respective periods. The closing prices as of March 31, 2003 and 2004 were $8.01 and $11.53, respectively.
As the table above illustrates, total pro forma expense for stock options includes $303,157,000 and $40,276,000 of expense during the three months ended March 31, 2003 and 2004, respectively, related to: (i) the Company's CEO's stock options that were cancelled for no consideration; (ii) stock options forfeited by employees upon termination for no consideration; and (iii) stock options that are significantly out of the money (e.g., the weighted-average exercise price of the out-of-the-money stock options was $21.95 per share compared to a closing price of $11.53 per share as of March 31, 2004). These items represented 99% and 85% of the pro forma expense in the above table for the three months ended March 31, 2003 and 2004, respectively.
The Company determined the assumptions used in computing the fair value of stock options or stock purchase rights as discussed in the remainder of this paragraph. The Company estimated the expected useful lives, giving consideration to the vesting and purchase periods, contractual lives, expected employee turnover, and the relationship between the exercise price and the fair market value of the Company's common stock, among other factors. The expected volatility was estimated giving consideration to the expected useful lives of the stock options, the Company's current expected growth rate, implied expected volatility in traded options for the Company's common stock, and recent volatility of the Company's common stock, among other factors. The risk-free rate is the U.S. Treasury bill rate for the relevant expected life. The fair value of stock options was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
Three Months Ended
March 31,
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2003 2004
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Risk-free interest rate................................................ 1.93 % 2.09 %
Expected life (in years)............................................... 3.0 3.4
Expected volatility.................................................... 65 % 42 %
Using the Black-Scholes option valuation model, stock options granted during the three months ended March 31, 2003 and 2004 had weighted average fair values of $3.63 and $4.39 per share, respectively.
The fair value of employees' stock purchase rights under the Company's employee stock purchase plans (the "Purchase Plan") was estimated using the Black-Scholes model with the following weighted average assumptions used for purchases:
Three Months Ended
March 31,
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2003 2004
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Risk-free interest rate................................................ 1.13 % 1.00 %
Expected life (in years)............................................... 0.5 0.5
Expected volatility.................................................... 63 % 46 %
The weighted average estimated fair value of the common stock purchase rights granted under the Purchase Plan during the three months ended March 31, 2003 and 2004 was $1.86 and $3.69 per share, respectively, including the 15% discount from the quoted market price.
Restructuring Obligations
In response to a deterioration of economic conditions, the Company initiated a Restructuring of its operations in July 2002, which the Company completed in December 2002 (the "2002 Restructuring"). The 2002 Restructuring was designed to better align the Company's operating structure with expected revenue levels. In connection with the 2002 Restructuring, the Company recorded restructuring and related expenses of $205,305,000.
Due in part to the continued weakening in the global economy and reduced revenue expectations, the Company initiated a further restructuring of its operations in the second quarter of 2003, which the Company completed in September 2003 (the "2003 Restructuring" and collectively with the 2002 Restructuring, the "2002 and 2003 Restructurings"). During 2003, the Company recorded restructuring and related expenses of $104,391,000 associated with the 2002 and 2003 Restructurings. This charge consisted of (i) $88,791,000 incurred in connection with the 2003 Restructuring, (ii) $14,891,000 incurred as a result of a change in estimate related to the 2002 Restructuring, and (iii) accretion expense of $709,000 associated with the 2003 Restructuring obligations.
The 2002 and 2003 Restructurings included the following key measures: (i) the reduction of the Company's workforce across all functional areas; (ii) the consolidation of its excess facilities; (iii) the abandonment of certain long-lived assets, including leasehold improvements, furniture and fixtures; and (iv) the transfer of certain technical support, quality assurance and other product development positions overseas to labor markets with lower cost structures.
The following table summarizes the restructuring and related expenses incurred during the three months ended March 31, 2004, and the remaining obligations related to the 2002 and 2003 Restructurings as of December 31, 2003 and March 31, 2004 (in thousands):
Employee Facility-
Termination Related
Costs (1) Costs (2) Total
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Restructuring obligations, December 31, 2003................ $ 3,805 $ 154,276 $ 158,081
Restructuring and related expenses:
Recognized related to changes in estimate................. 96 (101) (5)
Accretion related to the 2003 Restructuring (3)........... -- 603 603
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Total.................................................. 96 502 598
Cash payments............................................... (875) (12,761) (13,636)
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Restructuring obligations, March 31, 2004................... $ 3,026 $ 142,017 $ 145,043
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Less: Restructuring obligations, short-term............ 46,346
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Restructuring obligations, long-term................... $ 98,697
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The costs associated with the Company's workforce reductions consist primarily of severance payments, COBRA benefits, payroll taxes and other associated employment termination costs. The remaining obligations as of March 31, 2004 relate to approximately 90 terminations that have yet to be completed, primarily due to regulatory requirements in certain countries and the Company's ongoing transition of certain product development positions overseas. The Company expects to complete the reduction of the remaining employees within the next six months.
The costs associated with the Company's facilities consolidation primarily relate to lease termination costs, costs associated with satisfying remaining lease commitments, and expected brokerage and other re-letting costs, partially offset by estimated sublease income.
Represents the accretion of the 2003 Restructuring obligations. The Company will continue to accrete its obligations related to the 2003 Restructuring to the then present value and, accordingly, will recognize additional accretion expense as a Restructuring and related expense in future periods.
The total Restructuring charge and related cash outlay are based on management's current estimates, which may change materially if further consolidations are required or if actual lease-related expenditures or sublease income differ from amounts currently expected. The Company will review the status of its Restructuring activities quarterly and, if appropriate, record changes to its Restructuring obligations in current operations based on management's most current estimates.
Commitments and Contingencies
Legal Proceedings
On May 6, 2003, the Enforcement Division staff ("Staff") of the Securities & Exchange Commission ("SEC") contacted the Company and indicated that a May 1, 2003 article on CBS MarketWatch had raised questions regarding the Company's compliance with Regulation FD. In August 2003, the SEC Staff notified the Company and two of its officers of the SEC Staff's preliminary decision to recommend that the SEC take enforcement action against the Company and these officers in regard to statements allegedly made prior to and during an April 30, 2003 dinner. No such enforcement action has been initiated, and no findings have been issued. The Company and its officers have filed submissions with the SEC in response to the SEC notices and the Company believes that these submissions contain numerous meritorious defenses to these allegations. As the Company disclosed during its earnings call on January 21, 2004, it appears that this matter may soon go before the SEC for a decision. If the SEC decides to pursue this matter, the Company expects that it will continue though its normal course of civil action.
On March 10, 2004, William Wollrab, on behalf of himself and purportedly on behalf of a class of the Company's shareholders, filed an action in the United States District Court for the Northern District of California against the Company and certain of its officers. This action alleges claims in connection with various public statements made by the Company and seeks damages together with interest and reimbursement of costs and expenses of litigation. A number of follow-on actions have been filed alleging substantially similar claims. The Company believes the allegations in this action are without merit and it intends to defend vigorously against these claims.
In addition, the Company is subject to legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these proceedings and claims cannot be predicted with certainty, management does not believe that the outcome of any pending legal matter will have a material adverse effect on the Company's consolidated financial position, although results of operations or cash flows could be affected in a particular period.
Income and Payroll Taxes
The Company's U.S. Federal income tax returns for 1998, 1999 and 2000 are currently under examination by the Internal Revenue Service ("IRS"). During 2003 and 2004, the Company received notices from the IRS of proposed adjustments to these tax returns. While the final resolution of the IRS's ongoing examination is uncertain, the Company believes it has made adequate provision in the accompanying consolidated financial statements for any adjustments that the IRS has or may propose with respect to the U.S. Federal income tax returns. Based on currently available information, management believes that the ultimate outcome will not have a material adverse effect on the Company's financial position, cash flows or overall trends in results of operations. There exists the possibility that the Company may receive an assessment related to the audit of its U.S. income tax returns that exceeds amounts provided for by the Company. Any such assessment could have a material adverse impact on the Company's results of operations for the period in which the matter is ultimately resolved, or an unfavorable outcome becomes probable and reasonably estimable.
Certain of the Company's U.S. and international payroll tax returns, primarily related to stock option exercises, are currently under examination by the applicable taxing authority. The Company believes it has made adequate provision in the accompanying consolidated financial statements for any adjustments the taxing authorities may propose with respect to these payroll tax returns. There exists the possibility that the Company may receive an assessment related to the audit of its U.S. and international payroll tax returns that exceeds amounts provided for by the Company. In the event of such an assessment, there exists the possibility of a material adverse impact on the Company's results of operations for the period in which the matter is ultimately resolved, or an unfavorable outcome becomes probable and reasonably estimable.
Indemnifications
The Company sells software licenses and services to its customers under contracts which the Company refers to as Software License and Service Agreements (each an "SLSA"). Each SLSA contains the relevant terms of the contractual arrangement with the customer, and generally includes certain provisions for indemnifying the customer against losses, expenses, and liabilities from damages that may be awarded against the customer in the event the Company's software is found to infringe upon a patent, copyright, trademark, or other proprietary right of a third party. The SLSA generally limits the scope of and remedies for such indemnification obligations in a variety of industry-standard respects, including but not limited to certain time- and geography-based scope limitations and a right to replace an infringing product.
The Company believes its internal development processes and other policies and practices limit its exposure related to the indemnification provisions of the SLSA. In addition, the Company requires its employees to sign a proprietary information and inventions agreement, which assigns the rights to its employees' development work to the Company. To date, the Company has not had to reimburse any of its customers for any losses related to these indemnification provisions and no material claims are outstanding as of March 31, 2004. For several reasons, including the lack of prior indemnification claims and the lack of a monetary liability limit for certain infringement cases under the SLSA, the Company cannot determine the maximum amount of potential future payments, if any, related to such indemnification provisions.
Lease Obligations
As of March 31, 2004, the Company leased facilities and certain equipment under non-cancelable operating leases expiring between 2004 and 2022. The Company also leases certain assets, primarily computer equipment, under capital leases expiring between 2004 and 2005. Future minimum lease payments under both operating and capital leases as of March 31, 2004 are as follows (in thousands):
Capital Operating
Leases Leases
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Nine months ending December 31, 2004................ $ 9,127 $ 56,396
Year ending December 31, 2005....................... 6,500 68,023
Year ending December 31, 2006....................... -- 67,432
Year ending December 31, 2007....................... -- 67,467
Year ending December 31, 2008....................... -- 67,350
Year ending December 31, 2009, and thereafter....... -- 388,253
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Total minimum lease payments................... 15,627 $ 714,921
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Amounts representing interest.................. (730)
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Present value of minimum lease payments........ 14,897
Less: capital lease obligations, short-term
portion (included in accrued expenses)...... 10,288
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Capital lease obligations, long-term portion
(included in other long-term liabilities).... $ 4,609
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Operating lease commitments related to properties included in the 2002 and 2003 Restructurings are not reflected in the above table, as the Company has reflected the fair value of these obligations in the accompanying consolidated balance sheet under the caption "Restructuring obligations." Please refer to Note 2 for further discussion of the Restructuring obligations.
Acquisitions, Goodwill and Intangible Assets
Acquisitions
In January 2004, the Company acquired all of the outstanding securities of Ineto Services, Inc. ("Ineto"), a provider of hosted call center services over the Internet, for a net cash payment of $4,821,000. The Company has integrated Ineto's hosted telephony service, which the Company re-branded as Contact OnDemand, with its Siebel CRM OnDemand product offering. The Company expects the acquisition of Ineto to further accelerate its penetration of the hosted CRM market and expand customer choice in this market.
The Company allocated the purchase price of $4,821,000 to the tangible net assets and liabilities and intangible assets acquired, based on their estimated fair values as follows (in thousands):
Tangible assets:
Accounts receivable and other current assets... $ 507
Property and equipment......................... 40
Other assets-long term......................... 5
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Total tangible assets..................... 552
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Intangible assets:
Customer relationships......................... 1,250
Non-compete agreements......................... 750
Acquired technology............................ 500
Goodwill....................................... 3,842
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Total intangible assets................... 6,342
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Liabilities assumed:
Accounts payable and other accrued liabilities. (1,006)
Deferred revenue............................... (23)
Deferred tax liability......................... (1,000)
Other liabilities-long term.................... (44)
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Total liabilities assumed................. (2,073)
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Net assets acquired....................... $ 4,821
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The customer relationship intangible asset is being amortized over a period of six years based on the estimated customer attrition rates, currently estimated at approximately 30% per year of the remaining acquired customers. The non-compete agreements and acquired technology are being amortized over their estimated lives of two and three years, respectively, using the straight-line method. In performing this purchase price allocation, the Company considered, among other factors, its intention for future use of the acquired assets, analyses of historical financial performance and estimates of the future performance of the acquired business.
The excess of the purchase price over the fair value of the identifiable tangible and intangible net assets acquired of $3,842,000 was assigned to goodwill. In accordance with SFAS No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142"), goodwill will not be amortized but will be tested for impairment at least annually. This amount is not expected to be deductible for tax purposes. The operating results of Ineto have been included in the Company's consolidated financial statements from the date of acquisition. Pro forma information giving effect to this acquisition has not been presented because the pro forma information would not differ materially from the historical results of the Company.
Goodwill
The changes in the carrying amount of goodwill during the three months ended March 31, 2004 were as follows (in thousands):
Balance as of December 31, 2003..................... $ 140,957
Purchase of Ineto................................... 3,842
Foreign currency fluctuation and other.............. (4)
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Balance as of March 31, 2004........................ $ 144,795
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As required by SFAS 142, the Company does not amortize its goodwill balances, but instead tests its goodwill for impairment in accordance with the provisions of SFAS 142 annually on July 1 and more frequently upon the occurrence of certain events.
Intangible Assets
Intangible assets consist of the following (in thousands):
December 31, March 31,
2003 2004
------------ ------------
Gross assets:
Acquired technology.............................. $ 9,977 $ 10,477
Customer relationships........................... 6,700 7,950
Non-compete agreements........................... -- 750
------------ ------------
Intangible assets, gross...................... 16,677 19,177
------------ ------------
Accumulated amortization:
Acquired technology.............................. (5,549) (6,621)
Customer relationships........................... (342) (917)
Non-compete agreements........................... -- (63)
------------ ------------
Total accumulated amortization................ (5,891) (7,601)
------------ ------------
Intangible assets, net...................... $ 10,786 $ 11,576
============ ============
The Company is amortizing its intangible assets as follows: (i) acquired technology is being amortized using the straight-line method over the estimated useful lives, which range from fourteen months to three years (generally three years); (ii) the customer relationship intangible asset is being amortized over a period of six years based on the estimated customer attrition rates, currently estimated at approximately 30% per year of the remaining acquired customers; and (iii) the non-compete agreements are being amortized using the straight-line method over their estimated lives of two years. Based on identified intangible assets recorded as of March 31, 2004 and assuming no subsequent impairment of the underlying assets, amortization expense is expected to be as follows (in thousands):
Period
- ----------------------------------------------------
Nine months ending December 31, 2004................ $ 5,128
Year ending December 31, 2005....................... 2,464
Year ending December 31, 2006....................... 1,425
Year ending December 31, 2007....................... 893
Year ending December 31, 2008....................... 889
Year ending December 31, 2009, and thereafter....... 777
------------
Total.......................................... $ 11,576
============
Net Income per Share
The following is a reconciliation of the number of shares used in the basic and diluted net income per share computations for the periods presented (in thousands):
Three Months Ended
March 31,
---------------------
2003 2004
---------- ---------
Shares used in basic net income per share computation.................. 487,254 501,128
Effect of dilutive potential common shares resulting from stock
options and common stock warrants................................... 23,978 45,197
Effect of dilutive potential common shares resulting from common
stock subject to repurchase.......................................... 159 76
---------- ---------
Shares used in diluted net income per share computation................ 511,391 546,401
========== =========
The dilutive impact of the Company's stock options for the three months ended March 31, 2004 is calculated based on the average share price of the Company's common stock, using the treasury stock method. The average share price of the Company's common stock during the three months ended March 31, 2003 and 2004 was $8.57 and $13.23 per share, respectively. Under the treasury stock method, the proceeds that would be hypothetically received from the exercise of all stock options with exercise prices below the average share price of the Company's common stock are assumed to be used to repurchase shares of the Company's common stock.
The Company excludes all potentially dilutive securities from its diluted net income per share computation when their effect would be anti-dilutive. The following common stock equivalents were excluded from the earnings per share computation, as their inclusion would have been anti-dilutive (in thousands):
Three Months Ended
March 31,
---------------------
2003 2004
---------- ---------
Stock options excluded due to the exercise price exceeding
the average fair value of the Company's common stock
during the period.................................................... 87,761 63,033
Weighted average shares issuable upon conversion of the
convertible subordinated debentures.................................. 12,867 --
---------- ---------
Total common stock equivalents excluded from diluted net
income per share computation......................................... 100,628 63,033
========== =========
Under the treasury stock method, stock options with exercise prices exceeding the average share price of the Company's common stock during the applicable period are excluded from the diluted earnings per share computation. These stock options had weighted average exercise prices of $21.81 and $22.46 per share during the three months ended March 31, 2003 and 2004, respectively. The Company redeemed its $300,000,000 convertible subordinated debentures (the "Debentures") on September 30, 2003 and, accordingly, the Debentures are no longer outstanding and therefore are not potentially dilutive as of March 31, 2004.
Segment and Geographic Information
The Company and its subsidiaries are principally engaged in the design, development, marketing and support of Siebel eBusiness Applications, its family of industry-specific business software applications. Substantially all revenues result from the license of the Company's customer relationship management ("CRM") software products and related professional services and customer support (maintenance) services. The Company's chief operating decision-maker (i.e., chief executive officer) reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenues by geographic region for purposes of making operating decisions and assessing financial performance. Accordingly, the Company considers itself to be in a single reporting segment, specifically the license, implementation and support of its software.
The Company evaluates the performance of its geographic regions based only on revenues. The Company does not assess the performance of its geographic regions on other measures of income or expense, such as depreciation and amortization, operating income or net income. In addition, the Company's assets are primarily located in the United States and not allocated to any specific region. The Company does not produce reports for, or measure the performance of, its geographic regions on any asset-based metrics. Therefore, geographic information is presented only for revenues. The following geographic information for total revenues is presented for the three months ended March 31, 2003 and 2004 (in thousands):
March 31,
----------------------
2003 2004
----------- ----------
United States................................... $ 193,564 $ 196,774
Europe.......................................... 104,665 101,264
Asia Pacific.................................... 20,584 24,885
Canada and Latin America........................ 13,942 6,364
----------- ----------
$ 332,755 $ 329,287
=========== ==========
International software license revenues for the three months ended March 31, 2003 and 2004 were $57,354,000 and $57,223,000, respectively. The Company's international software license revenues are derived from countries principally in Europe and Asia Pacific, which includes Japan.
The following is a summary of the Company's software license revenues, by CRM product, for the three months ended March 31, 2003 and 2004 (in thousands):
March 31,
----------------------
2003 2004
Software license revenue by product: ----------- ----------
Sales, marketing and service automation........ $ 87,509 $ 95,712
Analytics...................................... 13,500 25,268
Employee relationship management ("ERM")....... 8,952 2,296
UAN and business integration applications...... 2,131 3,523
----------- ----------
Total..................................... $ 112,092 $ 126,799
=========== ==========
At times the Company licenses a combination of its products to its customers, with the actual product selection and number of licensed users determined subsequent to the initial license. The Company refers to these licenses as "Enterprise Licenses." The Company recognizes revenue from its Enterprise Licenses upon delivery of the first copy, or product master, for all of the products within the license, as all products have been licensed and delivered, and the customer has the right of use. During the three months ended March 31, 2003 and 2004, software license revenues from Enterprise Licenses were $15,366,000 and $23,065,000, respectively. The Company estimates the allocation of the revenue from these Enterprise Licenses to individual software products based upon the expected usage by its customers and in a manner consistent with its determination of compensation for its sales personnel. The actual deployment of Enterprise Licenses by the Company's customers may differ from the revenue allocated in the above table.
Although the Company believes the above methodology of allocating revenue from its Enterprise Licenses is reasonable, there can be no assurance that such allocated amounts reflect the amounts that would result had the Company individually licensed each specific software solution. Further, the Company generally does not re-evaluate the allocation of its revenue from Enterprise Licenses based on actual deployment by its customers.
The following is a summary of the Company's professional services, maintenance and other revenues, by service offering, for the three months ended March 31, 2003 and 2004 (in thousands):
March 31,
----------------------
2003 2004
----------- ----------
Maintenance..................................... $ 108,522 $ 114,877
Professional services and other................. 112,141 87,611
----------- ----------
Total....................................... $ 220,663 $ 202,488
=========== ==========
No single customer accounted for 10% or more of total revenues during the three months ended March 31, 2003 and 2004.
Subsequent Events
Acquisition of Eontec Limited
On April 20, 2004, the Company acquired all of the issued shares of Eontec Limited ("Eontec"), a global provider of multichannel retail banking solutions, for initial cash consideration of approximately $70,000,000. In the event certain revenue targets defined in the purchase agreement are met for the period from April 20, 2004 to March 31, 2005, the Company could be required to pay up to an additional $37,500,000 in cash to the former shareholders of Eontec and up to an additional $22,500,000 in cash to the former employees of Eontec who are employees of the Company at the time of payment. Any amounts paid by the Company to the Eontec shareholders will be recorded as additional purchase price and amounts paid to the former employees of Eontec will be recorded as compensation expense when earned.
The Company believes that Eontec's existing technology and certain products and functionality under development by Eontec at the time of purchase will enhance the Company's current offerings in the retail banking market. With this purchase, the Company expands its solutions offering for banking to include branch teller and Internet banking systems, creating one of the first retail banking solutions that enables banks to increase branch profitability using an integrated suite of financial transactions, marketing, sales, service, and business intelligence capabilities. The Company expects that its solution will also offer a standards-based, service oriented architecture to handle a wide range of customer interactions through multiple channels, including the branch, call center, Internet and ATM.
Because the Company purchased Eontec in such close proximity to the date of the filing of this quarterly report, the Company has not had an opportunity to determine the fair value of the assets acquired and liabilities assumed. Accordingly, it is not practicable to provide a purchase price allocation or the valuation of acquired intangible assets at this time. The Company is currently in the process of completing this analysis and expects to include the purchase price allocation in its quarterly report on Form 10-Q for the second quarter ending June 30, 2004. The operating results of Eontec will be included in the Company's consolidated financial statements from the date of purchase.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The statements contained in this quarterly report that are not historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements include, without limitation, statements regarding the extent and timing of future revenues, restructuring and other expenses and customer demand, statements regarding the development and deployment of our products, and statements regarding reliance on third parties. All forward-looking statements included in this quarterly report are based on information available to us as of the date of this quarterly report. We assume no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless we are required to do so by law. We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions, including those in the section entitled "Risk Factors" and elsewhere in this quarterly report.
Executive Summary
Our consolidated financial statements are included in Item 1 of this Quarterly Report on Form 10-Q. The following discussion is designed to provide a better understanding of these financial statements, including (i) a brief discussion of our business and products, (ii) key factors that impacted our performance, (iii) a summary of our operating results and certain key financial metrics, and (iv) our outlook for the second quarter of 2004, including certain risks that may impact our on-going operations. This executive summary should be read in connection with the more detailed discussion and analysis of our financial condition and results of operations in this Item 2, the section below entitled "Risk Factors", and our consolidated financial statements, which are included in Item 1 of this quarterly report.
Overview of Our Business and Products
We are a leading provider of business applications software for the customer relationship management, or CRM, market. Substantially all of our revenues are derived directly or indirectly from a perpetual license of our software products. Specifically, we license our software solutions in multi-element arrangements that include a combination of our software, customer support and/or professional services (e.g., training or implementation services). Payment terms for our customer arrangements are negotiated with the individual customer and determined based on a variety of factors, including the customer's credit standing and our history with the customer.
Our CRM applications enable an organization to better manage its relationships with its customers, partners and employees. A substantial portion of our software license revenue is derived from our sales, marketing and service automation solutions, which provide organizations with an integrated approach to identifying, acquiring and retaining customers. For example, these applications: (i) provide sales organizations with a comprehensive view into the sales pipeline, enabling sales professionals to identify specific actions that will help them better manage opportunities to rapid closure, (ii) assist marketing organizations to increase campaign response rates and reduce customer-acquisition costs, and (iii) assist service organizations to reduce response times with customers, improving customer satisfaction.
We also provide CRM software solutions that help organizations manage their employee relationships, better analyze corporate and customer data, and lower the cost of integrating software applications. Specifically, our employee relationship management applications enable an organization to increase employee and organizational performance and improve employee satisfaction by aligning employee performance with corporate objectives and providing employees with the information resources they need to be successful. Our business intelligence (otherwise known as analytics) and integration software applications help organizations to more fully leverage the value of their corporate information. Specifically, our analytics applications make it possible to analyze large volumes of corporate data quickly and easily, while our integration applications allow organizations to share data and processes among different software applications.
In addition to licensing our CRM applications on a per-user basis, we introduced Siebel CRM OnDemand in the fourth quarter of 2003. Siebel CRM OnDemand is a hosted software solution that provides CRM functionality over the Internet. Siebel CRM OnDemand is provided to our customers for a monthly per-user subscription fee, with a typical contractual period of one year. Siebel CRM OnDemand allows our customers to implement CRM software solutions quickly, easily and cost effectively. Siebel CRM OnDemand integrates with our on-premise licensed suite of products, enabling organizations to deploy our solutions in any combination of online hosted or on-premise delivery models.
Our Global Services Organization, which is comprised of our professional services and technical support organizations, provides: (i) implementation services (i.e., assistance with the integration of our software with the customers' other software and hardware applications), (ii) training services for our customers regarding how to use our software, and (iii) customer support services, otherwise known as maintenance, which include technical support for the related software product and future product updates.
Our professional services are typically initiated and provided over a period of three to nine months subsequent to the licensing of our software and, accordingly, our professional services revenues vary directly with the levels of software license revenue generated in the preceding three to nine month period. Substantially all of our professional service arrangements are billed on a time and materials basis. Maintenance is typically sold with the related software license for a period of one year and is renewable at the option of the customer on an annual basis thereafter. Our maintenance revenues depend upon both our ability to generate additional software license revenue and annual renewals of maintenance agreements by our existing customer base.
Internal Controls and Corporate Governance
We have historically considered our internal controls over financial reporting a high priority and will continue to do so through a continual review of and resulting improvement in our internal controls. For example, we substantially completed the documentation and testing of our internal controls as required by Section 404 of the Sarbanes-Oxley Act, or SOX, as of December 31, 2003. In accordance with SOX, we will test our internal controls each year and, accordingly, we have begun our testing for 2004 and expect to complete this testing in the third or fourth quarter. Based on the testing of our internal controls performed to date, we believe that our internal controls are functioning as designed and provide reasonable assurance that transactions are recorded as necessary to permit preparation of our financial statements in accordance with generally accepted accounting principles in the United States. With the work we have completed to date and planned, we believe that we are well-positioned for our auditors to issue their audit report on our internal controls at the end of 2004. In addition, we have formed an Internal Controls Committee, comprised primarily of senior financial and legal personnel, which helps ensure our internal controls over financial reporting are complete, accurate and appropriately documented.
In addition to maintaining robust internal controls, we follow high professional standards in measuring and reporting our financial performance. Specifically, we have adopted a code of ethics for all of our employees and directors, which requires a high level of professionalism and ethical behavior. We believe that our accounting policies are prudent and provide a clear view of our financial performance. We utilize our internal audit function to help ensure that we follow these accounting policies and maintain our internal controls. We have formed a Disclosure Committee, comprised primarily of senior financial and legal personnel, to help ensure the completeness and accuracy of our financial results and disclosures. In addition, prior to the release of our financial results, key members of our management review our operating results and key accounting policies and estimates with our Audit Committee, which is comprised solely of independent members of our Board of Directors. Please refer to the section entitled "Item 10. Directors and Executive Officers of the Registrant" of our Annual Report on Form 10-K for the year ended December 31, 2003 for a further discussion of our policies regarding corporate governance and our code of ethics.
Operating Environment during the Three Months Ended March 31, 2004
For the better part of two and half years (from the first quarter of 2001 to third quarter of 2003), macro-economic conditions either deteriorated or stabilized at depressed levels, with the information technology industry in which we operate disproportionately impacted. Beginning in the latter part of 2003, many key economic indicators, such as the U.S. gross domestic product, or GDP, and certain labor statistics, began to show signs of strengthening. Economic conditions appeared to continue to strengthen in the first quarter of 2004, with improvement in many economic indicators such as the GDP, productivity, labor statistics and consumer confidence, among others. We believe capital spending--and more specifically information technology spending--continues to stabilize and may also be showing signs of strengthening. As an example, during the first quarter of 2004 we were able to grow our software license revenues, operating income and net income on a year-over-year basis for the first time since economic conditions began deteriorating at the beginning of 2001.
While corporations remain cautious in setting and executing on their capital spending budgets, due in part to continued concerns regarding potential terrorist attacks and further geopolitical conflicts, we believe that corporations are becoming more "cautiously optimistic." For example, recent surveys indicate a growing number of information technology executives plan to increase their company's spending on selective information technology in 2004. While it is still too early to determine if the improvement in information technology spending will continue, we are cautiously optimistic that our operating results may continue to improve both on a year-over-year basis and on a sequential quarterly basis.
Summary of Our Operating Results for 2004 and Certain Key Financial Metrics
During the first quarter of 2004, we continued to improve the majority of our operating metrics, including year-over-year increases in our software license revenues of 13% and net income of over 500%. In addition, we continued to improve our operating margin on a year-over-year basis, achieving an operating margin of 11.4% in the first quarter of 2004. We believe the majority of this improvement is due to the continued recovery in the economy discussed above and previous actions taken by management in 2002 and 2003, including the restructuring of our operations, reorganization of our worldwide sales organization and certain cost control initiatives. The following is a brief summary of our key financial metrics and operating results for the three months ended March 31, 2003 and 2004 (in thousands, except EPS, percentages and DSO):
Three Months Ended March 31,
----------------------------
2003 2004
------------ -------------
Revenues:
Software license................................. $ 112,092 $ 126,799
Maintenance...................................... 108,522 114,877
Professional services and other.................. 112,141 87,611
------------ -------------
Total revenues.............................. $ 332,755 $ 329,287
============ =============
Annualized total revenue per employee............ $ 226 $ 269
============ =============
Other key operating statistics:
Total cost and expenses.......................... $ 336,042 $ 291,585
Operating income (loss).......................... $ (3,287) $ 37,702
Operating margin................................. (1)% 11 %
Earnings per share, diluted ("EPS").............. $ 0.01 $ 0.06
Cash flows from operations....................... $ 62,811 $ 89,799
December 31, March 31,
2003 2004
------------ -------------
Other key financial statistics:
Cash and short-term investments.................. $ 2,023,206 $ 2,132,927
Days sales outstanding ("DSO")................... 64 63
Working capital.................................. $ 1,708,898 $ 1,788,076
Total stockholders' equity....................... $ 2,050,226 $ 2,112,214
Software license revenues increased by 13% from $112.1 million for the three months ended March 31, 2003 to $126.8 million for the three months ended March 31, 2004, primarily due to: (i) a greater breadth of our products and the strength of our analytics products, UAN product and industry-specific versions of our products; (ii) an improving global economy; (iii) the realignment of our worldwide sales organization into three geographic operating units-the Americas, Europe Middle East and Africa ("EMEA"), and Asia Pacific; and (iv) an increase in the number of customer evaluations of CRM applications, with a conversion rate comparable to our historical win rates.
Maintenance revenues
Professional services and other revenues,
Due to the recent improvement of our software license revenues in the last six months (i.e., the fourth quarter of 2003 and first quarter of 2004), we believe our professional services and other revenues are stabilizing and may likely return to sequential quarterly growth in the second quarter of 2004. Returning our professional services revenues to sequential quarterly growth continues to be one of our primary goals for 2004.
Total revenue per employee
Total quarterly costs and expenses
Operating margin
Earnings and EPS
Cash and short-term investments
Deferred revenues
Credit and collections
Working capital
Stockholders' equity
Stock option overhang
Outlook for the Second Quarter of 2004
We intend to continue to work to improve the above financial metrics, including returning our professional services and other revenues to sequential quarterly growth. For the second quarter of 2004, we currently anticipate that our total revenues will continue to increase sequentially from the first quarter to between $340 million and $365 million. We expect the individual components of our total revenues to be within the following ranges:
Our expectations regarding our revenues may be negatively impacted by many factors, including: (i) a deterioration in global economic conditions and/or information technology spending; (ii) additional terrorist attacks; (iii) geopolitical uncertainties, including continued hostilities involving the United States; (iv) corporate and consumer confidence in the economy; (v) continued intense competition, including new technological innovations within our industry; (vi) the uncertainty in the application software industry and resulting reductions in capital expenditures; (vii) the loss of key employees; and (viii) other factors described under "Risk Factors" below.
We expect "total costs and expenses" to increase in the second quarter of 2004 from the levels incurred in the first quarter of 2004, primarily due to: (i) increased expenditures resulting from our acquisition of Eontec Limited ("Eontec") in April 2004 (please refer to Note 7 to the accompanying unaudited consolidated financial statements for a further discussion of our acquisition of Eontec), and (ii) an increase in expenses that vary directly with revenue levels such as "cost of revenues" and commissions. Partially offsetting these increases, we expect to continue to realize cost savings from the 2003 Restructuring and additional reductions in depreciation expense from our cost control initiatives. As a result of the anticipated increase in our revenues coupled with our continued expense controls, we expect operating income and margin for the second quarter of 2004 to remain comparable to or increase from levels obtained in the first quarter of 2004. Our expectations regarding operating income are directly dependent upon our ability to continue to grow software license revenues and return our professional services and other revenues to sequential quarterly growth.
Uncertainty with respect to the timing and amount of our future revenues could significantly impact the above expectations and our future operations. Our sales personnel monitor the status of all proposals, including the estimated closing date and potential dollar amount of each transaction. We aggregate these estimates periodically to generate a sales pipeline and then evaluate the pipeline to identify trends in our business. This pipeline analysis and related estimates of revenue may differ significantly from actual revenues in a particular reporting period as the estimates and assumptions were made using the best available data at the time. A variation in the pipeline or in the conversion rate of the pipeline into contracts could cause us to plan or budget inaccurately and thereby could adversely affect our business, financial condition or results of operations. In addition, because a substantial portion of our software license contracts close in the latter part of a quarter, management may not be able to adjust our cost structure to respond to a variation in the conversion of the pipeline, which may adversely and materially affect our business, financial condition and results of operations.
We expect other income, net to remain comparable in the second quarter of 2004 to levels obtained in the first quarter of 2004.
We currently expect our effective tax rate for the second quarter of 2004 to be approximately 36%. The estimated effective tax rate is based on current tax law and our expected annual income and may be affected by the jurisdictions in which profits are determined to be earned and taxed and our ability to realize deferred tax assets.
As discussed in Note 3 to the accompanying unaudited consolidated financial statements, our U.S. Federal income tax returns for 1998, 1999 and 2000 are currently under examination by the Internal Revenue Service ("IRS"). During 2003 and 2004, we received notices from the IRS of proposed adjustments to these tax returns. While the final resolution of the IRS's ongoing examination is uncertain, we believe that we have made adequate provision in the accompanying consolidated financial statements for any adjustments that the IRS has or may propose with respect to our U.S. Federal income tax returns. The final determination of our tax obligations may exceed the amounts provided by us in the accompanying consolidated financial statements. We will continually review our estimates related to our income tax obligations, including potential assessments from the IRS of additional taxes, penalties and/or interest, and revise our estimates, if deemed necessary. A revision in our estimates of our tax obligations will be reflected as an adjustment to our income tax provision at the time of the change in our estimates. Such a revision could materially impact our effective tax rate, income tax provision and net income.
Discussion of the Results of Operations for the Three Months Ended March 31, 2003 and 2004
Revenues
Our total revenues during the first quarter of 2004 remained comparable with levels obtained in the first quarter of 2003, with a slight decrease of 1%, or $3.5 million, from $332.8 in the 2003 period to $329.3 million in the 2004 period. We were able to maintain our total revenues at nearly the same levels in 2003, primarily due to a 13%, or $14.7 million, year-over-year increase in our software license revenues. The growth of our software license revenues partially offset an 8%, or $18.2 million, year-over-year decrease in our professional services, maintenance and other revenues. As more fully described below, we believe our professional services, maintenance and other revenues decreased on year-over-year basis during the first quarter of 2004 due to previous declines in our software license revenues that occurred in the first nine months of 2003 (i.e., trends in these revenues generally lag software license revenues by up to nine months).
While our total revenues decreased slightly from the first quarter of 2003 to the first quarter of 2004, we continued to improve our total revenue per average employee, one of our key operating metrics. Specifically, our total revenue per average employee increased from $226,000 per employee in the first quarter of 2003 and $249,000 per employee for the full year 2003 to $269,000 per employee for the first quarter of 2004. This represents one of our best quarters, measured in terms of total revenue per employee, in the last three years and we expect this metric may continue to improve in the second quarter of 2004.
In order to provide a better understanding of the year-over-year changes in our total revenue, we have provided the following discussion of each of the individual components of our total revenues:
Software
The following table sets forth our software license revenues and certain key metrics related to our software license revenues for the three months ended March 31, 2003 and 2004 (in thousands, except percentages and number of transactions):
Three Months Ended March 31,
-------------------------
2003 2004
----------- ------------
Software license revenue metrics:
Software license revenues................................... $ 112,092 $ 126,799
Percentage of total revenues................................ 33.7 % 38.5 %
Year-over-year change, absolute dollars..................... -- $ 14,707
Year-over-year change, percentage........................... -- 13 %
Other key software license metrics:
Number of transactions equal to or greater than $5 million.. 2 3
Number of transactions between $1 and $5 million............ 32 26
Total number of transactions................................ 397 306
Average transaction size.................................... $ 282 $ 414
Software license revenues increased on a year-over-year basis by $14.7 million, or 13%, from the first quarter of 2003 to the first quarter of 2004, with significant increases in the majority of our product lines. Much of this growth was related to our newest product lines, analytics and business integration applications, which increased on a year-over-year basis by over 80% and 60%, respectively. Our sales, marketing and service automation products increased on a year-over-year basis by 9%, primarily due to the strength of our industry-specific versions of our products. The following is a summary of our software license revenues by CRM product for the three months ended March 31, 2003 and 2004 (in thousands):
March 31,
----------------------
2003 2004
Software license revenue by product: ----------- ----------
Sales, marketing and service automation........ $ 87,509 $ 95,712
Analytics...................................... 13,500 25,268
Employee relationship management ("ERM")....... 8,952 2,296
UAN and business integration applications...... 2,131 3,523
----------- ----------
Total..................................... $ 112,092 $ 126,799
=========== ==========
We believe the increase in our software license revenues is due primarily to: (i) a greater breadth of our products; (ii) an improving global economy; (iii) the realignment of our worldwide sales organization into three geographic operating units-the Americas; Europe, Middle East and Africa ("EMEA"); and Asia Pacific; and (iv) an increase in the number of customer evaluations of CRM applications, with a conversion rate comparable to our historical win rates (i.e., we were able to maintain or increase our market share in the majority of our product categories).
In addition to increases in our software license revenues in terms of absolute dollars and as a percentage of total revenues, many of our key software license metrics (described in the above table) improved on a year-over-year basis. The following is a discussion of these key metrics:
The number of our higher dollar value transactions increased, with the number of deals generating software license revenue equal to or greater than $5 million increasing from two in the first quarter of 2003 to three in the first quarter of 2004. Further, while the number of transactions generating software license revenue between $1 million and $5 million decreased on a year-over-year basis, a greater proportion of these transactions were in the $2 to $4 million range in 2004 compared to 2003.
The average software license transaction size increased from $282,000 in the first quarter of 2003 to $414,000 in the first quarter of 2004 (our best performance in over two years). Much of this increase is due to a significant increase in the number of new customer engagements, which typically purchase higher quantities of our software in the initial purchase. Specifically, software license revenues from new customers or new projects at existing customers increased to 61% during the first quarter of 2004 compared to a range of 50% to 55% during each of the last three years.
We believe this continued expansion of our customer base will provide us with a competitive advantage through increased future sales opportunities, particularly as corporate capital expenditures return to normalized levels.
While the total number of transactions decreased from 397 to 306, the majority of the decrease related to our smallest orders (i.e., transactions with total license revenues of less than $50,000). These transactions have not historically accounted for a significant portion of our software license revenue. Further, the increase in our average software license transaction size more than offset the reduction in the number of software license transactions.
We market our products through our direct sales force and to a limited extent through distributors, primarily in Europe, Asia Pacific, Japan and Latin America. International license revenues accounted for 51% and 45% of software license revenues during the three months ended March 31, 2003 and 2004, respectively. We expect international software license revenues will continue to account for a significant portion of our overall software license revenues in the foreseeable future. Because the majority of our software license arrangements and related operating activities are denominated in U.S. dollars, foreign currency did not have a significant impact on software license revenues, total revenues or net income for any period presented.
Professional Services, Maintenance and Other
Professional services, maintenance and other revenues are primarily comprised of professional services (i.e., implementation services and training) and maintenance (i.e., technical support and product updates). Also included in professional services, maintenance and other revenues for the first quarter of 2004 is revenue from our newest product offering, Siebel CRM OnDemand, which we introduced in the fourth quarter of 2003. The revenues derived from Siebel CRM OnDemand were not significant for the first quarter of 2004. Our professional services are typically initiated and provided over a period of three to nine months subsequent to the licensing of our software and depend in large part upon our software license revenues in the immediate preceding periods. Our maintenance revenues depend upon both our software license revenues and renewals of maintenance agreements by our existing customer base.
Professional services, maintenance and other revenues decreased by $18.2 million, or 8%, from $220.7 million for the three months ended March 31, 2003 to $202.5 million for the three months ended March 31, 2004. This decrease was primarily due to a decline in revenues derived from our implementation and training services (i.e., professional services), partially offset by an increase in the installed base of customers receiving maintenance. In order to better understand the changes within our professional services, maintenance and other revenues, we have provided the following table, which sets forth the individual components of these revenues in terms of absolute dollars and as a percentage of total revenues (in thousands, except percentages):
Three Months Ended March 31,
-------------------------
2003 2004
----------- ------------
Maintenance revenues:
Absolute dollars............................................ $ 108,522 $ 114,877
Percentage of total revenues................................ 32.6 % 34.9 %
Year-over-year change, absolute dollars..................... -- $ 6,355
Year-over-year change, percentage........................... -- 6 %
Professional services and other revenues:
Absolute dollars............................................ $ 112,141 $ 87,611
Percentage of total revenues................................ 33.7 % 26.6 %
Year-over-year change, absolute dollars..................... -- $ (24,530)
Year-over-year change, percentage........................... -- (22)%
Our maintenance revenues increased by $6.4 million, or
6%, from $108.5 million in the first quarter of 2003 to $114.9 million in the
first quarter of 2004. As a percentage of total revenues, maintenance revenues
increased from 33% for the three months ended March 31, 2003 to 35% for the
three months ended March 31, 2004. The increase in absolute dollars and the
increase as a percentage of total revenues were due primarily to stable renewal
rates among our existing customer base and new maintenance agreements associated
with additional licenses of our software to new and existing customers.
While maintenance revenues have continued to increase on a year-over-year basis, professional services and other revenues decreased by $24.5 million, or 22%, from the first quarter of 2003 to the first quarter of 2004. As a percentage of total revenues, professional services revenues decreased from 34% in the 2003 period to 27% in the 2004 period. We believe this decline was primarily due to: (i) a lag effect, as discussed further below, related to our software license revenues; (ii) a decline of $2.2 million related to rebillable travel and entertainment ("T&E") expenses, which decreased in part due to lower demand for our professional services and resulting decline in the utilization of our professional services personnel; (iii) a decline in our professional services revenue in North America; and (iv) the effect of the transition to new leadership in our Global Services Organization.
While each of these factors impacted our professional services and other revenues, we believe the primary reason for the decrease in these revenues is a lag effect related to our software license revenues. Specifically, our implementation and training services are initiated and performed over a period of three to nine months subsequent to the initial software license and, as a result, our implementation and training services typically vary directly with the amount of software license revenues generated in the preceding three- to nine-month period. Accordingly, we believe the decrease in our professional services and other revenues is primarily the result of previous declines in our software license revenues that occurred in the first nine months of 2003.
We are optimistic that our professional services and other revenues will return to sequential quarterly growth in 2004, as we expect the impact of the recent increases in our software license revenues (i.e., the fourth quarter of 2003 and the first quarter of 2004) will begin to be realized in our professional services and other revenues in the second and third quarters of 2004 (i.e., trends in our software license revenues are typically realized within a three- to nine-month period).
Further, we have taken and will continue to take steps to improve the performance of our Global Services Organization and return our professional service revenues to positive sequential quarterly growth. We are committed to realizing the benefits of these efforts in an expansion of our professional services' margins, including further cost controls, if necessary, to achieve our gross margin goals. Despite our focus to grow our professional service revenues, we expect to balance our growth initiatives with our desire to manage our professional services organization to ensure that it does not compete with our implementation partners.
Cost of Revenues
Total cost of revenues decreased on a year-over-year basis from the first quarter of 2003 to the first quarter of 2004 by $19.1 million, or 15%, and decreased as a percentage of total revenues from 39% (a gross margin of 61%) in the 2003 period to 34% (a gross margin of 66%) during the 2004 period. The decline in total cost of revenues in terms of absolute dollars was due primarily to cost savings from the 2003 Restructuring, our cost controls and further reductions in our professional services staff commensurate with the decline in our professional services and other revenues. The decline of total cost of revenues as a percentage of total revenues was due to each of the above factors, along with an increase in the percentage of our total revenues derived from our higher margin software and maintenance revenues.
In order to better understand the changes within our cost of revenues and resulting gross margins, we have provided the following discussion of the individual components of our cost of revenues:
Software
The following table sets forth our cost of software license revenues in terms of absolute dollars and as a percentage of software license revenues for the three months ended March 31, 2003 and 2004 (in thousands, except percentages):
Three Months Ended March 31,
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2003 2004
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Cost of software license revenues:
Absolute dollars............................................ $ 4,721 $ 3,207
Percentage of software license revenues..................... 4.2 % 2.5 %
Year-over-year change, absolute dollars..................... -- $ (1,514)
Year-over-year change, percentage........................... -- (32)%
Cost of software license revenues includes amortization of acquired technology, third-party software royalties, and product packaging, production and documentation. All costs incurred in the research and development of software products and enhancements to existing products have been expensed as incurred.
Cost of software license revenues decreased in absolute dollars and as a percentage of software license revenues from the first quarter of 2003 to the first quarter of 2004 primarily due to a reduction of $1.3 million from the cessation of amortization expense related to the technology acquired from Sales.com, Inc., which was written-off at the time of abandonment in July 2003.
Professional Services, Maintenance and Other
The following table sets forth our cost of professional services, maintenance and other revenues in terms of absolute dollars and as a percentage of these revenues for the three months ended March 31, 2003 and 2004 (in thousands, except percentages):
Three Months Ended March 31,
-------------------------
2003 2004
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Cost of professional services, maintenance
and other revenues:
Absolute dollars............................................ $ 125,512 $ 107,925
Percentage of professional services, maintenance
and other revenues....................................... 57 % 53 %
Year-over-year change, absolute dollars..................... -- $ (17,587)
Year-over-year change, percentage........................... -- (14)%
Cost of professional services, maintenance and other revenues consist primarily of personnel, facilities and systems costs incurred to provide training, consulting, technical support and other global services. These costs decreased from the first quarter of 2003 to the first quarter of 2004 by $17.6 million, or 14%, primarily as a result of the following:
A net decrease of $5.7 million in personnel costs resulting from our reduction of personnel in response the decline in the demand for our professional services (average headcount in our Global Services Organization decreased from 2,410 in the first quarter of 2003 to 2,020 in the first quarter of 2004).
A decrease of $3.0 million in outside consulting expenses resulting from our reduced use of outside consultants, commensurate with the decline in our implementation revenues and decline in utilization rates of our own personnel.
A decrease of $2.2 million in rebillable T&E expenses due in part to lower demand for our professional services and resulting decline in the utilization of our professional services personnel.
A decrease of $4.3 million in facility-related costs resulting from the consolidation of our facilities in connection with the 2003 Restructuring.
A decrease of $3.4 million due to the further realization of savings from our cost control initiatives, including reductions in depreciation expense of $1.9 million and non-billable travel and entertainment expenditures of $1.5 million.
Partially offsetting these cost savings were increases in compensation costs from the renewal of merit increases and certain other incentive compensation.
Cost of professional services, maintenance and other revenues as a percentage of the corresponding revenues decreased from 57% in the first quarter of 2003 to 53% in the first quarter of 2004, primarily due to: (i) a higher percentage of our professional services, maintenance and other revenues being derived from our higher-margin maintenance revenues in the 2004 period compared to the 2003 period; and (ii) our ability to reduce personnel, facility and other costs as described above. Primarily as a result of these factors, our gross margin related to our professional services maintenance and other revenues improved from 43% in the first quarter of 2003 to 47% in the first quarter of 2004. This year-over-year improvement in our gross margin was partially offset by a decline in the utilization rates of our professional services staff.
Operating Expenses
Product Development
The following table sets forth our product development expense in terms of absolute dollars and as a percentage of total revenues for the three months ended March 31, 2003 and 2004 (in thousands, except percentages):
Three Months Ended March 31,
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2003 2004
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Product development expense:
Absolute dollars............................................ $ 79,271 $ 72,024
Percentage of total revenues................................ 24 % 22 %
Year-over-year change, absolute dollars..................... -- $ (7,247)
Year-over-year change, percentage........................... -- (9)%
Product development expense includes costs associated with the development of new products, enhancements of existing products, quality assurance activities and vertical engineering. These costs consist primarily of employee salaries and benefits, occupancy costs, consulting costs and the cost of software development tools and equipment. Product development expense decreased from the first quarter of 2003 to the first quarter of 2004 by $7.2 million, or 9%, primarily due to cost savings from our 2003 Restructuring and our cost control initiatives, including reductions in depreciation expense and discretionary expenditures such as travel and entertainment.
Specifically, we have reduced the average headcount in our product development organization from 1,610 in the first quarter of 2003 to 1,315 in first quarter of