UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 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, 2005
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 22, 2005 was 516,674,822.
SIEBEL SYSTEMS, INC.
FORM 10-Q
For the Quarterly Period Ended March 31, 2005
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, 2004 and March 31, 2005 |
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Consolidated Statements of Operations and Comprehensive Income (Loss) for the three months ended March 31, 2004 and 2005 |
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Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2005 |
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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 5. Other Information |
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| Item 6. Exhibits |
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| Signature |
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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,
2004 2005
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Assets
Current assets:
Cash and cash equivalents........................................... $ 560,377 $ 545,340
Short-term investments.............................................. 1,686,111 1,650,936
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Total cash, cash equivalents and short-term investments...... 2,246,488 2,196,276
Accounts receivable, net............................................ 293,527 254,951
Deferred income taxes............................................... 17,542 22,542
Prepaids and other.................................................. 53,894 34,396
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Total current assets......................................... 2,611,451 2,508,165
Property and equipment, net............................................ 83,908 78,568
Goodwill............................................................... 208,306 286,886
Intangible assets, net................................................. 23,004 42,693
Other assets........................................................... 36,937 33,757
Deferred income taxes.................................................. 123,828 116,487
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Total assets................................................. $ 3,087,434 $ 3,066,556
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Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable.................................................... $ 10,048 $ 18,522
Accrued expenses.................................................... 346,672 266,652
Restructuring obligations........................................... 30,639 29,953
Deferred revenue.................................................... 357,223 365,979
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Total current liabilities.................................... 744,582 681,106
Restructuring obligations, less current portion........................ 75,227 67,354
Other long-term liabilities............................................ 20,981 24,506
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Total liabilities............................................ 840,790 772,966
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Commitments and contingencies
Stockholders' equity:
Common stock; $0.001 par value; 2,000,000 shares authorized;
508,953 and 516,095 shares issued and outstanding, respectively... 509 516
Additional paid-in capital........................................... 1,635,652 1,723,011
Deferred compensation................................................ (2,993) (13,150)
Accumulated other comprehensive income............................... 70,541 44,277
Retained earnings.................................................... 542,935 538,936
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Total stockholders' equity................................... 2,246,644 2,293,590
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Total liabilities and stockholders' equity................... $ 3,087,434 $ 3,066,556
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See accompanying notes to consolidated financial statements.
SIEBEL SYSTEMS, INC.
Consolidated Statements of Operations and Comprehensive Income (Loss)
(in thousands, except per share data; unaudited)
Three Months Ended
March 31,
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2004 2005
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Revenues:
Software license........................................... $ 126,799 $ 74,978
Professional services, maintenance and other............... 202,488 223,960
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Total revenues......................................... 329,287 298,938
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Cost of revenues:
Software license........................................... 3,207 3,898
Professional services, maintenance and other............... 108,214 112,964
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Total cost of revenues................................. 111,421 116,862
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Gross margin...................................... 217,866 182,076
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Operating expenses:
Product development........................................ 72,633 74,717
Sales and marketing........................................ 86,398 92,274
General and administrative................................. 21,699 25,618
Restructuring and related expenses......................... 571 492
Purchased in-process product development................... -- 10,890
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Total operating expenses............................... 181,301 203,991
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Operating income (loss)........................... 36,565 (21,915)
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Other income (expense), net:
Interest and other income, net............................. 12,075 15,994
Interest expense........................................... (320) (231)
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Total other income (expense), net...................... 11,755 15,763
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Income (loss) before income taxes................. 48,320 (6,152)
Income taxes (benefit)........................................ 17,340 (2,153)
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Net income (loss)................................. $ 30,980 $ (3,999)
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Diluted net income (loss) per share........................... $ 0.06 $ (0.01)
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Basic net income (loss) per share............................. $ 0.06 $ (0.01)
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Shares used in diluted share computation...................... 546,401 512,963
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Shares used in basic share computation........................ 501,128 512,963
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Comprehensive income (loss):
Net income (loss)............................................. $ 30,980 $ (3,999)
Other comprehensive income (loss), net of taxes:
Foreign currency translation adjustments................... (3,844) (18,765)
Realized loss (gain) on marketable investments previously
recognized in other comprehensive income................ (1,123) 143
Unrealized gain (loss) on investments, net................. 4,163 (7,643)
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Other comprehensive income (loss)...................... (804) (26,265)
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Total comprehensive income (loss)................. $ 30,176 $ (30,264)
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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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2004 2005
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Cash flows from operating activities:
Net income (loss)....................................................... $ 30,980 $ (3,999)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Write-off of purchased in-process product development................ -- 10,890
Depreciation and other amortization.................................. 31,478 18,019
Amortization of identifiable intangible assets....................... 1,710 3,088
Stock-based compensation, net........................................ 195 1,012
Provision for (recovery of) doubtful accounts and sales returns...... (1,000) --
Tax benefit from exercise of stock options........................... 1,500 51,379
Deferred income taxes................................................ (465) --
Net realized loss (gain) on cost-method investments.................. 1,083 (2,059)
Net realized loss (gain) on marketable investments................... (1,872) 238
Changes in operating assets and liabilities:
Accounts receivable............................................... 30,234 51,900
Prepaids and other................................................ 14,305 22,171
Accounts payable and accrued expenses............................. (33,843) (95,742)
Restructuring obligations......................................... (13,641) (9,051)
Deferred revenue.................................................. 29,135 71
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Net cash provided by operating activities....................... 89,799 47,917
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Cash flows from investing activities:
Purchases of short-term investments..................................... (413,446) (249,872)
Sales and maturities of short-term investments.......................... 382,507 268,648
Purchases of property and equipment, net................................ (225) (3,096)
Proceeds from sale of venture investments............................... -- 4,979
Purchase consideration for acquired businesses, net of cash received.... (4,817) (93,088)
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Net cash used in investing activities........................... (35,981) (72,429)
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Cash flows from financing activities:
Proceeds from issuance of common stock.................................. 29,379 24,749
Repayments of capital lease obligations................................. (3,278) (2,024)
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Net cash provided by financing activities....................... 26,101 22,725
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Effect of exchange rate fluctuations....................................... (3,766) (13,250)
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Change in cash and cash equivalents........................................ 76,153 (15,037)
Cash and cash equivalents, beginning of period............................. 546,542 560,377
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Cash and cash equivalents, end of period................................... $ 622,695 $ 545,340
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See accompanying notes to consolidated financial statements.
SIEBEL SYSTEMS, INC.
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, 2004. 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, 2005 and the three months ended March 31, 2004 and 2005 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, 2004.
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, 2005. 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 on-going 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.
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, if any, related to its stock-based compensation as follows:
Stock options—The Company records and measures deferred compensation for stock options granted to its employees and members of its Board of Directors when the market price of the underlying stock exceeds the exercise price of the stock option on the date of the grant. The Company records and measures deferred compensation for stock options granted to non-employees based on the fair value of the stock options.
Restricted stock and restricted stock units ("RSUs")—The Company records and measures deferred compensation for restricted stock and RSUs based on the market price of the Company's common stock on the date of grant.
Deferred compensation is expensed on a straight-line basis over the respective vesting period of the equity instrument. The terms of Company's stock options and restricted stock vary, but generally provide for ratable vesting over five years, with 20% of the underlying shares vesting one year from grant and the remaining shares vesting 5% quarterly thereafter. The vesting terms of the Company's RSUs range from approximately three months to five years. The Company did not grant any stock options at exercise prices below the fair market value of the Company's common stock during any period presented.
An alternative 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 record deferred compensation based on the fair value of the stock option at the date of grant as determined using the Black-Scholes option valuation model. The deferred compensation calculated under the fair value method would then be amortized on a straight-line basis 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. In accordance with SFAS 123, in preparing this reconciliation the Company must first add back all stock-based compensation expense reflected in its statement of operations, then deduct the stock-based employee compensation expense determined under SFAS 123. Summarized below are the pro forma effects on the Company's earnings and earnings per share, 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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2004 2005
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Net income (loss):
As reported..................................................... $ 30,980 $ (3,999)
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Compensation expense related to:
Stock options dilutive to stockholders:
Stock-based compensation accounted for under APB 25........... 195 1,012
In-the-money stock options and restricted stock units......... (4,308) (4,224)
Stock purchase rights under the Purchase Plan................. (2,559) (2,228)
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Subtotal................................................... (6,672) (5,440)
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Stock options not dilutive to stockholders:
Out-of-the-money stock options................................ (37,336) (23,355)
Stock options forfeited in connection with terminations....... (3,135) --
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Subtotal................................................... (40,471) (23,355)
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Total pro forma expense giving effect to SFAS 123.......... (47,143) (28,795)
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Tax benefit related to SFAS 123 expense..................... -- 2,287
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Pro forma net loss giving effect to SFAS 123................ $ (16,163) $ (30,507)
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Diluted net income (loss) per share:
As reported..................................................... $ 0.06 $ (0.01)
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Pro forma giving effect to SFAS 123............................. $ (0.03) $ (0.06)
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Basic net income (loss) per share:
As reported..................................................... $ 0.06 $ (0.01)
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Pro forma giving effect to SFAS 123............................. $ (0.03) $ (0.06)
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The Company has provided a tax benefit on the pro forma expense in the above table in a manner consistent with the Company's accounting for deferred tax assets resulting from the exercise of employee stock options in the accompanying consolidated financial statements. Accordingly, the Company has not provided a tax benefit on the pro forma expense in the above table during the first quarter of 2004.
During the first quarter of 2005, the Company determined that it would be able to utilize certain net operating loss carryforwards ("NOL") associated with stock option exercises that occurred in previous years. As a result of the utilization of these NOLs, the Company has reflected a $51.4 million increase to additional paid-in capital in the accompanying unaudited consolidated financial statements. In accordance with SFAS 123, the Company's tax benefit in the above table associated with this utilization of NOLs is limited to the lesser of the actual tax benefit in the Company's income tax return or the SFAS 123 pro forma expense associated with these same options. As a result of the tax benefit exceeding the SFAS 123 pro forma expense, the Company's pro forma tax benefit was limited to $2.3 million compared to the $51.4 million tax benefit reflected as an increase to additional paid-in capital.
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, 2004 and 2005 were $11.53 and $9.13, respectively.
As the table above illustrates, total pro forma expense for stock options includes $40.5 million and $23.4 million of expense during the three months ended March 31, 2004 and 2005, respectively, related to (i) stock options forfeited by employees upon termination for no consideration and (ii) 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 $20.20 per share compared to a closing price of $9.13 per share as of March 31, 2005). These items represented 86% and 81% of the pro forma expense during the three months ended March 31, 2004 and 2005, respectively.
The Company determined the assumptions used in computing the fair value of its stock options and stock purchase rights issued under its employee stock purchase plan (the "Purchase Plan") as follows:
Expected Life
In determining the appropriate expected life of its stock options, the Company segregates its optionholders into the following categories: (i) CEO and members of its Board of Directors, (ii) officers and (iii) non-officer employees. The Company determined these categories based on its experience that its CEO, officers and members of its Board of Directors generally hold stock options for longer periods than its non-officer employees.
The Company estimated the expected useful lives for each of these categories giving consideration to (i) the weighted average vesting periods (e.g., options that vest over five years have a weighted-average vesting period of 2.7 years), (ii) the contractual lives of the stock options, (iii) the relationship between the exercise price and the fair market value of the Company's common stock, (iv) expected employee turnover, (v) the expected future volatility of the Company's common stock, and (v) past and expected exercise behavior, among other factors.
During 2005 the Company's weighted average expected life assumption increased compared to 2004, primarily due to (i) an increase in the weighted average vesting period (i.e., for 65% of all stock options granted during the first quarter of 2005, the weighted average vesting period increased from 2.7 to 3.0 years) and (ii) the continued low levels of volatility of the Company's common stock (i.e., lower volatility historically results in a longer stock option life).
Volatility
The Company estimated expected volatility 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. In considering these factors, the Company noted that (i) the stock market in general, and its common stock in particular, have continued to become less volatile and (ii) implied volatility in traded options for the Company's common stock has continued to decrease relative to previous periods.
Risk-Free Interest Rate
The Company estimated the risk-free interest rate using 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 valuation model with the following weighted average assumptions:
Three Months Ended
March 31,
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2004 2005
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Risk-free interest rate............. 2.09 % 4.11 %
Expected life (in years)............ 3.4 3.6
Expected volatility................. 42 % 40 %
Using the Black-Scholes option valuation model, stock options granted during the three months ended March 31, 2004 and 2005 had weighted average fair values of $4.39 and $2.99 per share, respectively.
The fair value of employees' stock purchase rights granted under the Purchase Plan was estimated using the Black-Scholes option valuation model with the following weighted average assumptions:
Three Months Ended
March 31,
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2004 2005
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Risk-free interest rate............. 1.00 % 2.71 %
Expected life (in years)............ 0.5 0.5
Expected volatility................. 46 % 38 %
The weighted average fair value of the common stock purchase rights granted under the Purchase Plan during the three months ended March 31, 2004 and 2005 was $3.69 and $2.27 per share, respectively, including the 15% discount from the quoted market price.
Recent Accounting Pronouncements
Stock-Based Compensation
In December 2004, the FASB issued SFAS No. 123 (Revised 2004) "Share-Based Payment" ("SFAS 123R"), a revision to SFAS 123. SFAS 123R addresses all forms of share-based payment ("SBP") awards, including shares issued under the Purchase Plan, stock options, restricted stock, restricted stock units and stock appreciation rights. SFAS 123R will require the Company to record compensation expense for SBP awards based on the fair value of the SBP awards.
Under SFAS 123R, restricted stock and restricted stock units will generally be valued by reference to the market value of freely tradable shares of the Company's common stock. Stock options, stock appreciation rights and shares issued under the Purchase Plan will generally be valued at fair value determined through an option valuation model, such as a lattice model or the Black-Scholes model (the model that the Company currently uses for its footnote disclosure). SFAS 123R is effective for annual periods beginning after June 15, 2005 and, accordingly, the Company must adopt the new accounting provisions effective January 1, 2006.
Income Taxes
In December 2004, the FASB issued two FASB Staff Positions ("FSP") related to the recently enacted American Jobs Creation Act of 2004 ("AJCA"). FSP No. 109-1 "Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities" ("FSP 109-1") requires companies that qualify for a deduction for domestic production activities under the AJCA to account for the deduction as a special deduction under FASB Statement No. 109.
FSP No. 109-2 "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004" ("FSP 109-2") allows companies additional time to evaluate whether foreign earnings will be repatriated under the repatriation provisions of the AJCA and requires specified disclosures for companies needing the additional time to complete the evaluation. Once a decision is made to repatriate the foreign earnings, companies must reflect the deferred tax liabilities attributable to foreign earnings in the period that the decision is made to remit those earnings.
Restructuring Obligations
During 2002, 2003 and 2004, the Company initiated a series of restructurings designed to better align its operating structure with expected revenue levels (the "2002 Restructuring," the "2003 Restructuring" and the "2004 Restructuring," and collectively the "Restructurings"). The 2002 Restructuring and 2003 Restructuring 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 to labor markets with lower cost structures.
In order to continue to reduce expense levels and to further improve the Company's operating margins, the Company initiated an additional restructuring of its operations during the third quarter of 2004. The 2004 Restructuring consisted primarily of the consolidation of additional facilities (located primarily in North America and Asia Pacific) and the abandonment of the related leasehold improvements and furniture and fixtures.
The following table summarizes the restructuring and related expenses incurred during the three months ended March 31, 2005, and the remaining obligations related to the Restructurings as of December 31, 2004 and March 31, 2005 (in thousands):
Employee Facility-
Termination Related
Costs (1) Costs (2) Total
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Restructuring obligations, December 31, 2004............ $ 265 $ 105,601 $ 105,866
Restructuring and related expenses:
Accretion related to the Restructurings (3)........... -- 492 492
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Total.............................................. -- 492 492
Cash payments........................................... (24) (9,027) (9,051)
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Restructuring obligations, March 31, 2005............... $ 241 $ 97,066 $ 97,307
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Less: Restructuring obligations, short-term........ 29,953
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Restructuring obligations, long-term............... $ 67,354
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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 termination costs incurred in connection with the 2003 Restructuring. The remaining obligations as of March 31, 2005 relate to less than five terminations that have yet to be completed, primarily due to regulatory requirements in certain countries outside the U.S. The Company expects to complete these terminations within 2005.
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.
The Company will continue to accrete its obligations related to the Restructurings 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 Actions
Regulation FD
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 Staff notified the Company and two of its officers of the 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. The Company and its officers filed submissions with the SEC in response to the SEC notices that the Company believes contained numerous meritorious defenses to these allegations. Despite these submissions, on June 29, 2004, the SEC filed a lawsuit in the United States District Court of the Southern District of New York against the Company and the two officers alleging, among other things, that the Company and its officers violated Regulation FD in connection with the statements described above.
In September 2004, the Company filed a motion to dismiss the complaint. A hearing on the motion occurred on March 15, 2005. The Company believes the allegations in this action are without merit and it intends to defend vigorously against them. Due to the uncertainty surrounding the litigation process, there exists the possibility that the Company may incur costs in excess of amounts already recognized. The Company cannot currently estimate the amount of such additional costs, if any.
Stock Option Grant Inquiry
On March 7, 2005, the SEC provided the Company with a copy of an order of investigation regarding certain stock option grants by a number of companies, including the Company. The SEC has advised the Company that this is a confidential fact finding inquiry and has confirmed that the issuance of the order does not indicate that it has concluded that the Company has violated any securities laws. The Company intends to cooperate with the SEC as this investigation continues to develop. In accordance with the disclosures required by SFAS 5, the Company is unable to estimate the potential financial impact this matter could have on the Company.
Shareholder Class Actions
On March 10, 2004, William Wollrab, on behalf of himself and purportedly on behalf of a class of the Company's stockholders, filed a complaint in the United States District Court for the Northern District of California against the Company and certain of its officers. This complaint was consolidated and amended on August 27, 2004, with the Policemen's Annuity and Benefit Fund of Chicago being appointed to serve as lead plaintiff. In October 2004, the Company filed a motion for dismissal of this case, which was granted on January 28, 2005. Plaintiffs in this case filed a second amended complaint on February 28, 2005, and the Company intends to file a motion to dismiss as soon as practical.
On April 12, 2004, Pamela Plotkin, on behalf of herself and purportedly on behalf of a class of the Company's stockholders, filed a complaint in the Superior Court of California (the "Superior Court") against the Company and certain members of the Company's Board of Directors. The Superior Court dismissed the complaint by Ms. Plotkin on September 23, 2004, but gave Ms. Plotkin leave to file a new, amended complaint, which was subsequently filed by Ms. Plotkin. The Superior Court dismissed the amended complaint on December 28, 2004, but again gave Ms. Plotkin leave to file a new, amended complaint. Ms. Plotkin filed a new amended complaint on January 14, 2005. On February 2, 2005, the parties to this complaint agreed to stay (i.e., place on hold) the entire case until June 1, 2005.
These complaints allege claims in connection with various public statements made by the Company and seek damages together with interest and reimbursement of costs and expenses of litigation. The Company believes the allegations in each of these actions are without merit and it intends to defend vigorously against these claims.
General
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, Payroll and Sales and Use Tax Audits
Income Tax Audits
In March of 2005 the Company received formal notification from the Internal Revenue Service ("IRS") that its examination of the Company's U.S. federal income tax returns for 1998 through 2000 has been completed. The final settlement with the IRS was consistent with the preliminary settlement disclosed in our annual report on Form 10-K for the year ended December 31, 2004. The Company determined that as a result of the settlement, it would be able to utilize certain NOL carryforwards associated with stock option exercises that occurred in previous years. The majority of the final settlement of $54.3 million was offset by available NOL carryforwards of $51.4 million associated with previous exercises of stock options. The Company has reflected the utilization of these NOLs as an increase to additional paid-in capital in the accompanying unaudited consolidated financial statements. The remaining portion of the settlement is expected to result in a cash outlay of approximately $2.9 million, which has been accrued by the Company. The Company's U.S. federal income tax returns for 2001 through 2003 remain under examination by the IRS.
While the final resolution of the IRS's on-going examination of the Company's income tax returns remains 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 of these examinations will not have a material adverse effect on the Company's financial position, cash flows or results of operations.
Payroll Taxes
The Company's U.S. payroll tax returns for 1999 through 2003 are currently under examination by the IRS, primarily related to the timing of the payment of taxes associated with stock option exercises. While the Company has not received any notices of proposed adjustments with respect to this examination, the Company expects that the IRS may issue a notice of proposed adjustment to its payroll tax returns in 2005. While the final resolution of this on-going examination of the Company's payroll tax returns is uncertain, based on currently available information, the Company believes it has made adequate provision in the accompanying consolidated financial statements for any adjustments that may result from the IRS audit of the Company's U.S. payroll tax returns.
Sales, Use and Value Added Taxes
The Company's sales and use tax returns in various states in the United States for 2000 through 2003 and certain international sales and value added tax returns for 2002 through 2004 are currently under examination and/or review by the applicable taxing authorities. While the final resolutions of these on-going examinations are uncertain, the Company believes it has made adequate provision in the accompanying consolidated financial statements for any adjustments that may result from the audits of these tax returns.
Summary
The Company may receive assessments related to the audits and/or reviews of its U.S. and foreign income tax returns, payroll tax returns, sales and use tax returns, and value added tax returns that exceed 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. Due to the uncertainty surrounding the audit/review process, there exists the possibility that the Company may incur costs in excess of amounts already recognized; however, the amount of such additional loss, if any, is not currently 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 key 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 the right to replace an infringing product.
The Company believes its internal development processes and other policies and practices are designed to 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, with limited exception, 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, 2005. For several reasons, including the lack of prior indemnification claims and the lack of a monetary liability limit for certain infringement claims under the SLSA, the Company cannot determine the amount of potential future payments, if any, related to such indemnification provisions.
Lease Obligations
As of March 31, 2005, the Company leased facilities and certain equipment under non-cancellable operating leases expiring between 2005 and 2022. The Company also leases certain assets, primarily computer equipment, under capital leases expiring in 2007. Future minimum lease payments under both operating and capital leases as of March 31, 2005 are as follows (in thousands):
Capital Operating
Leases Leases
--------- ------------
Nine months ending December 31, 2005................ $ 5,924 $ 54,637
Year ending December 31, 2006....................... 1,599 67,488
Year ending December 31, 2007....................... 1,599 64,494
Year ending December 31, 2008....................... -- 63,993
Year ending December 31, 2009....................... -- 63,164
Year ending December 31, 2010, and thereafter....... -- 311,166
--------- ------------
Total minimum lease payments................... 9,122 $ 624,942
============
Amounts representing interest.................. (415)
---------
Present value of minimum lease payments........ 8,707
Less: capital lease obligations, short-term
portion (included in accrued expenses)...... 6,034
---------
Capital lease obligations, long-term portion
(included in other long-term liabilities).... $ 2,673
=========
Operating lease commitments related to properties included in the 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
The following is a summary of the Company's acquisitions during 2004 and 2005, each of which has been accounted for as a purchase:
2005 Acquisitions
Acquisition of edocs, Inc.
On January 14, 2005, the Company acquired all of the issued and outstanding shares of edocs, Inc. ("edocs"), a leading provider of electronic bill presentment and customer self-service software solutions, for initial consideration of approximately $118.5 million ("Initial Purchase Price"). The Initial Purchase Price consisted of the following: (i) the payment of cash consideration of $101.7 million, (ii) purchase consideration payable of $15.0 million and (iii) transaction costs of $1.8 million, consisting primarily of professional fees incurred related to investment bankers, attorneys, accountants and valuation advisors. As of March 31, 2005, the Company had paid $103.2 million of the Initial Purchase Price and expects to pay the remaining $15.3 million during the second quarter of 2005.
In the event certain revenue targets and other contractual milestones defined in the purchase agreement are met for 2005, the Company could be required to pay up to an additional $42.5 million in cash to the former shareholders of edocs. Any amounts paid by the Company to the edocs' shareholders will be recorded as an increase to goodwill.
edocs' solutions enable companies to improve customer service and increase customer loyalty while reducing the cost of serving their customers. Companies use edocs' solutions to move the most common customer inquiries and transactions—such as billing, account management and service order issues—from expensive channels such as paper correspondence and contact center calls to lower-cost self-service and assisted care channels such as the web, email and chat.
The Company believes that edocs' existing technology and certain products and functionality under development by edocs at the time of purchase will enhance the Company's current self-service offerings. The Company plans to integrate its CRM solutions with edocs' customer service and electronic bill presentment applications to deliver one of the industry's most comprehensive self-service solutions enabling companies to drive higher levels of customer satisfaction and adoption.
The Company allocated the Initial Purchase Price to the tangible net assets and liabilities and intangible assets acquired, based on their estimated fair values. Under the purchase method of accounting, the Initial Purchase Price does not include the contingent earnout amounts described above. The Initial Purchase Price has been allocated as follows (in thousands):
Tangible assets:
Cash and cash equivalents................................ $ 10,081
Accounts receivable and other current assets............. 15,883
Property and equipment................................... 1,747
Other assets, long-term.................................. 30
---------
Total tangible assets............................... 27,741
---------
Intangible assets:
Acquired technology...................................... 20,270
Customer relationships................................... 3,260
Customer contracts....................................... 120
Acquired in-process research and development ("IPR&D")... 10,890
Goodwill................................................. 82,166
---------
Total intangible assets............................. 116,706
---------
Liabilities assumed:
Accounts payable and accrued liabilities................. (9,938)
Accrued purchase price and acquisition-related expenses.. (15,359)
Deferred revenue......................................... (8,639)
Deferred tax liability................................... (7,342)
---------
Total liabilities assumed........................... (41,278)
---------
Net assets acquired................................. $103,169
=========
In performing the purchase price allocation of acquired intangible assets, the Company considered its intention for future use of the assets, analyses of historical financial performance and estimates of future performance of edocs' products, among other factors. In addition to the identifiable intangible assets in the above table, the Company also purchased certain technologies being developed by edocs at the time of the acquisition, which is commonly referred to as IPR&D. The IPR&D acquired primarily related to edocs' products designed specifically for the telecommunications, healthcare and credit card industries.
Because the IPR&D had not yet reached technological feasibility and had no alternative future use, the Company reflected a $10.9 million expense under the heading "purchased in-process product development" in the accompanying unaudited statements of operations for 2005. At the date of the Company's acquisition of edocs, there were six products under development, with percentage completion for each of the IPR&D products ranging from approximately 50% to 75%. The Company expects to incur between $1.5 and $2.5 million to complete the development of these products. The Company expects to complete these products at various dates in 2005.
The Company determined the fair values of the above identifiable intangible assets and the IPR&D using the "income" valuation approach and discount rates ranging from 15% to 32%. The discount rates selected were based in part on considerations of the rate of return implied by the purchase price and the risk associated with achieving forecasted cash flows for edocs. Further, the Company also considered risks associated with achieving anticipated levels of market acceptance and penetration, successful completion of various research and development efforts, market growth rates and risks related to the impact of potential changes in future target markets.
The acquired technology and customer contract intangible assets are currently being amortized over their estimated useful lives of four years and one year, respectively, using the straight-line method. The customer relationship intangible assets are currently being amortized over their estimated useful lives of six years based on the greater of the straight-line method or the estimated customer attrition rates.
The excess of the purchase price over the fair value of the identifiable tangible and intangible net assets acquired of $82.2 million 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 deductible for tax purposes.
The following table presents unaudited summarized combined results of operations of the Company and edocs, on a pro forma basis, as though the companies had been combined as of January 1, 2004. Because the acquisition was completed near the beginning of the first quarter of 2005, the pro forma information for this period would not differ materially from the actual results of the Company presented herein and therefore has not been included below. The operating results of edocs have been included in the Company's consolidated financial statements from the date of acquisition. The following unaudited pro forma amounts are in thousands, except the per share amount:
Three Months
Ended
March 31, 2004
---------------
Total revenues.............................. $ 339,949
Net income.................................. $ 27,702
Diluted net income (loss) per share......... $ 0.05
The above unaudited pro forma summarized results of operations are intended for informational purposes only and, in the opinion of management, are neither indicative of the financial position or results of operations of the Company had the acquisition actually taken place as of January 1, 2004, nor indicative of the Company's future results of operations. In addition, the above unaudited pro forma summarized results of operations do not include potential cost savings from operating efficiencies or synergies that may result from the Company's acquisition of edocs.
2004 Acquisitions
Acquisition of Eontec Limited
On April 20, 2004, the Company acquired all of the outstanding issued share capital of Eontec Limited ("Eontec"), a global provider of multichannel retail banking solutions, for initial cash consideration of $73.6 million (the "Initial Consideration"). The Initial Consideration consisted of the following: (i) the payment of cash consideration of $70.0 million for all of the outstanding securities of Eontec and (ii) transaction costs of $3.6 million, consisting primarily of professional fees incurred related to investment bankers, attorneys, accountants and valuation advisors.
As a result of Eontec meeting certain revenue-related targets, as defined in the purchase agreement, for the period from April 20, 2004 to March 31, 2005, the Company may be required to pay the former holders of Eontec common stock additional consideration of $15.8 million, subject to offset for certain claims, if any, that the Company is entitled to under the purchase agreement. Amounts paid to the former holders of Eontec common stock, if any, will be recorded as an increase to goodwill at the time of payment.
The following table presents unaudited summarized combined results of operations of the Company and Eontec, on a pro forma basis, as though the companies had been combined as of January 1, 2003. The operating results of Eontec have been included in the Company's consolidated financial statements from the date of acquisition. The following unaudited pro forma amounts are in thousands, except the per share amount:
Three Months
Ended
March 31, 2004
---------------
Total revenues.............................. $ 331,788
Net loss.................................... $ 23,649
Diluted net loss per share.................. $ 0.04
The above unaudited pro forma summarized results of operations are intended for informational purposes only and, in the opinion of management, are neither indicative of the financial position or results of operations of the Company had the acquisition actually taken place as of January 1, 2003, nor indicative of the Company's future results of operations. In addition, the above unaudited pro forma summarized results of operations do not include potential cost savings from operating efficiencies or synergies that may result from the Company's acquisition of Eontec.
Intangible Assets and Goodwill
Goodwill
The changes in the carrying amount of goodwill during the three months ended March 31, 2005 were as follows (in thousands):
Balance as of December 31, 2004................ $ 208,306
Purchase of edocs.............................. 82,166
Foreign currency fluctuation and other......... (3,586)
-----------
Balance as of March 31, 2005................... $ 286,886
===========
The Company tests its goodwill for impairment annually on July 1 and more frequently upon the occurrence of certain events in accordance with the provisions of SFAS 142.
Intangible Assets
Intangible assets as of December 31, 2004 and March 31, 2005, along with the weighted average useful lives as of March 31, 2005, are as follows (in thousands, except years):
Wtd. Avg.
December 31, March 31, Life
2004 2005 (in Years)
------------ ------------ -----------
Gross assets:
Acquired technology..................... $ 14,103 $ 33,705 4.2
Customer relationships.................. 12,673 15,677 5.6
Customer contracts...................... 2,880 2,844 3.4
Non-compete agreements.................. 750 750 2.0
------------ ------------ -----------
Intangible assets, gross............. 30,406 52,976 4.6
------------ ------------
Accumulated amortization:
Acquired technology..................... (2,696) (4,394)
Customer relationships.................. (3,425) (4,207)
Customer contracts...................... (937) (1,245)
Non-compete agreements.................. (344) (437)
------------ ------------
Total accumulated amortization....... (7,402) (10,283)
------------ ------------
Intangible assets, net............. $ 23,004 $ 42,693
============ ============
The Company is amortizing its intangible assets as follows: (i) acquired technology, customer contracts and non-compete agreements are currently being amortized over their estimated useful lives using the straight-line method and (ii) customer relationship intangible assets are currently being amortized over their estimated useful lives based on the greater of the straight-line method or the estimated customer attrition rates. Based on identified intangible assets recorded as of March 31, 2005 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, 2005........... $ 9,030
Year ending December 31, 2006.................. 10,842
Year ending December 31, 2007.................. 9,802
Year ending December 31, 2008.................. 9,544
Year ending December 31, 2009.................. 2,776
Year ending December 31, 2010, and thereafter.. 699
-----------
Total..................................... $ 42,693
===========
Net Income (Loss) per Share
The following is a reconciliation of the number of shares used in the basic and diluted net income (loss) per share computations for the periods presented (in thousands):
Three Months Ended
March 31,
--------------------
2004 2005
---------- ---------
Shares used in basic net income (loss) per share computation............. 501,128 512,963
Effect of dilutive potential common shares resulting from
stock options......................................................... 45,197 --
Effect of dilutive potential common shares resulting from restricted
stock units and common stock subject to repurchase..................... 76 --
---------- ---------
Shares used in diluted net income (loss) per share computation........... 546,401 512,963
========== =========
Shares used in the diluted net income (loss) per share computation in the above table include the dilutive impact of the Company's stock equivalents (i.e., stock options, restricted stock and RSUs). Because the Company reported a net loss during the three months ended March 31, 2005, the Company excluded the impact of its common stock equivalents in the computation of dilutive earnings per share for this period, as their effect would be anti-dilutive. The dilutive impact of the Company's common stock equivalents for the three months ended March 31, 2004 is calculated using the treasury stock method, based on the average share price of the Company's common stock during this period of $13.23 per share. 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 earnings 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,
--------------------
2004 2005
---------- ---------
Stock options excluded due to the exercise price exceeding
the average fair value of the Company's common stock
during the period...................................................... 63,033 65,265
Weighted average common stock equivalents, calculated using
the treasury stock method, that were excluded due to the
Company reporting a net loss during the period......................... -- 27,460
---------- ---------
Total common stock equivalents excluded from diluted net
income (loss) per share computation.................................... 63,033 92,725
========== =========
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 $22.46 and $20.12 per share during the three months ended March 31, 2004 and 2005, respectively. In addition, as discussed above, stock options with exercise prices equal to or below the average fair value of the Company's common stock were excluded from the diluted earnings per share computation because the Company reported a net loss during the three months ended March 31, 2005. The weighted average fair value of the Company's common stock during the three months ended March 31, 2005 was $8.91 per share.
Restricted Stock and Restricted Stock Units
Restricted Stock
On January 31, 2005, the Nominating and Corporate Governance Committee of the Company's Board of Directors approved 2005 compensation for its non-employee directors such that each non-employee director would receive compensation equivalent to the fair value of a stock option to purchase 20,000 shares of the Company's common stock (based on the Black-Scholes valuation model and the fair market value of the Company's common stock on the date of grant) to be allocated as follows: 50% in cash and 50% in shares of restricted stock that vest in full on January 31, 2006. Accordingly, in the first quarter of 2005 the Company awarded each of its non-employee directors compensation of $32,500 in cash and 3,750 shares of restricted stock (an aggregate of 22,500 shares) that will vest in full on January 31, 2006 in consideration for their service as a director in 2005. The Company recorded deferred compensation of $0.2 million related to this issuance of restricted stock, which is being expensed on a straight-line basis over the one-year vesting period.
As of December 31, 2004 and March 31, 2005, a total of 71,000 and 90,000 shares, respectively, of the Company's common stock remain subject to repurchase by the Company. In the event an employee or member of the Company's Board of Directors discontinues service prior to the expiration of the vesting period, the Company may repurchase any unvested shares of the restricted stock at the lower of (i) the original purchase price of the restricted stock or (ii) the fair value of the Company's common stock. The Company's right to repurchase the shares lapses over the vesting period of the restricted stock. No compensation expense has resulted at the time of the repurchases of the Company's restricted shares since the consideration paid by the Company equaled the lower of (i) the original purchase price of the restricted stock or (ii) the fair value of the Company's common stock.
Restricted Stock Units
RSUs are similar to restricted stock in that they are issued for no, or nominal, consideration; however, the holder generally is not entitled to the underlying shares of common stock until the RSU vests. The following table presents the activity related to RSUs during the first quarter of 2005:
Number of
RSUs
-------------
Balances as of December 31, 2004............... 332,500
RSUs granted to employees.................... 919,361
RSUs granted to officers..................... 355,000
RSUs vested during period.................... (12,500)
RSUs canceled due to employee termination.... (8,650)
-------------
Balances as of March 31, 2005.................. 1,585,711
=============
The Company recorded an aggregate of $11.0 million of deferred compensation during the three months ended March 31, 2005 in connection with the issuance of these RSUs, which the Company is amortizing on a straight-line basis over the respective vesting periods. The RSUs granted during the first quarter of 2005 generally vest on the fourth anniversary of the date of grant; provided, however that a portion of the RSUs will accelerate and become vested upon achievement of all or a specified portion of certain defined objective financial performance goals.
Specifically, the Compensation Committee has approved the following four performance goals for 2005 and 2006:
The revenue-based targets set forth above will be adjusted upward to incorporate any revenue from companies acquired during the relevant year (excluding the acquisition of edocs in 2005) and the operating margin-based targets will be adjusted for the impact of any acquisitions and certain unusual charges (e.g., stock-based compensation, restructuring expenses, etc.).
For each goal that is fully achieved, vesting will be accelerated for 25% of the total shares granted, such that half of such accelerated shares will vest on January 31 of the year in which the Compensation Committee determines that a goal has been met and the remaining half will vest on January 31 of the following year.
Segment and Geographic Information
The Company is principally engaged in the design, development, marketing and support of Siebel Business Applications, its family of front-office business software applications. Substantially all revenues result from the license of the Company's front-office 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 using 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, 2004 and 2005 (in thousands):
Three Months Ended
March 31,
----------------------
2004 2005
----------- ----------
United States............................... $ 196,774 $ 179,052
Europe...................................... 101,264 97,834
Asia Pacific................................ 24,885 13,804
Canada and Latin America.................... 6,364 8,248
----------- ----------
$ 329,287 $ 298,938
=========== ==========
International software license revenues for the three months ended March 31, 2004 and 2005 were $57.2 million and $32.1 million, respectively, representing 45% and 43% of software license revenues, 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 front-office product, for the three months ended March 31, 2004 and 2005 (in thousands):
Three Months Ended
March 31,
----------------------
2004 2005
----------- ----------
Sales, marketing and service automation.. $ 98,008 $ 54,686
Customer and business analytics.......... 25,268 17,448
Customer data integration................ 3,523 2,844
----------- ----------
Total............................... $ 126,799 $ 74,978
=========== ==========
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, 2004 and 2005, software license revenues from Enterprise Licenses were $23.1 million and $5.5 million, 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 reevaluate 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, 2004 and 2005 (in thousands):
Three Months Ended
March 31,
----------------------
2004 2005
----------- ----------
Maintenance............................... $ 114,877 $ 122,578
Professional services and other........... 87,611 101,382
----------- ----------
Total................................. $ 202,488 $ 223,960
=========== ==========
No single customer accounted for 10% or more of total revenues during the three months ended March 31, 2004 and 2005.
Subsequent Events
On April 12, 2005, the Company's chief executive officer ("CEO"), J. Michael Lawrie, resigned as both the Company's CEO and as a member of its Board of Directors. In connection with Mr. Lawrie's resignation, the Company entered into a Separation and Consulting Agreement (the "Agreement") dated April 15, 2005. Pursuant to the Agreement and consistent with the severance terms of his offer letter, the Company made a cash payment of $4.5 million to Mr. Lawrie, which represents his base salary and targeted annual cash bonus for two years. Under the Agreement, Mr. Lawrie will also receive certain other benefits, including healthcare benefits for a period of one year following separation.
Further, under the Agreement and consistent with the terms of Mr. Lawrie's offer letter, the 200,000 unvested shares of Mr. Lawrie's RSU for 350,000 shares of common stock (150,000 shares had already vested pursuant to the normal vesting schedule), and 800,000 shares of his outstanding stock option to purchase shares of our common stock, immediately vested in full upon his resignation. As a result of the acceleration of vesting of Mr. Lawrie's RSU, the Company recognized $1.2 million of expense, representing the remaining unamortized deferred compensation associated with the RSUs, in April 2005.
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 our consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance, a summary of our operating results and certain key financial metrics, and our outlook for the second quarter of 2005. 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 entitled "Risk Factors" in this Item 2, and our consolidated financial statements and notes 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 front office. We consider the front office to include those areas of business activity that involve customer interactions, such as sales, marketing and service. We are principally engaged in the design, development, marketing, sale and support of our front-office business applications. A majority of our revenues are derived from perpetual licenses of our software products, the related professional services, such as training and implementation services, and the related customer support, otherwise known as maintenance. Specifically, we license our software in arrangements in which the customer purchases a combination of software, maintenance and/or professional services. Payment terms for our arrangements are negotiated with our customers and are based on a variety of factors, including the customer's credit standing and our history with the customer.
Siebel Business Applications—our comprehensive family of front-office business applications—are designed to help organizations better manage their customer, partner and employee relationships, analyze critical customer data, and execute customer-focused business processes. Our applications are designed to support these critical tasks while meeting the information technology requirements of any kind of organization, any type of user and any budget. Siebel Business Applications can be installed on premise, delivered as a hosted service over the Internet, or deployed as a combination of the two.
A substantial portion of our front-office business applications is focused on the customer relationship management, or CRM, market. CRM is an integrated approach to identifying, acquiring and retaining customers in order to help organizations maximize the value of customer interactions and improve corporate performance. Our sales, service and marketing applications are designed to help organizations perform and coordinate these operations across multiple communication channels (such as the Internet, telephone, fax, email and in person) and different lines of business, while providing their customers with a single, consistently high standard of service. The partner relationship management component of our CRM applications is designed to help an organization work collaboratively with its partners and resellers in one comprehensive information system in order to increase revenues, drive customer satisfaction and reduce partnership management costs.
Our front-office solutions also include our customer and business intelligence applications (also known as analytics), customer data integration solutions, and a deeper set of service offerings to assist our customers in maximizing the value received from our products. Specifically, our analytics applications assist customers in analyzing large volumes of corporate data quickly and easily. These analytics applications can access and aggregate information contained in systems across the enterprise—including financial management, human resources and supply chain systems—helping managers and front-line employees make informed decisions. Our customer data integration solutions enable organizations to more fully leverage the value of their corporate information by allowing them to share data and processes among different software applications.
In addition to licensing our applications on a per-user basis, we also offer two hosted software solutions, Siebel CRM OnDemand and Siebel Contact OnDemand, as services available over the Internet. Siebel CRM OnDemand offers customers CRM and analytics functionality and Siebel Contact OnDemand offers customers call center functionality. We provide these OnDemand solutions for a monthly per-user subscription fee, with a typical contractual period of one year. Our OnDemand solutions allow our customers to implement software solutions quickly, easily and cost-effectively. Our OnDemand solutions integrate with the on-premise Siebel Application Suite, enabling organizations to deploy our solutions in any combination of online hosted or on-premise delivery models.
Siebel Services, our professional services organization, provides (i) implementation services (i.e., assistance with the integration of our software with other software and hardware applications), (ii) change management services (i.e., end user adoption consulting and training services for our customers regarding how to better use our software), (iii) testing and managed services (i.e., assistance with operating, maintaining, testing and optimizing our applications) and (iv) technical support and customer care services (i.e., trouble-shooting the related software products and future product updates). Siebel Services has significant product and implementation expertise and is committed to supporting customers and systems integrators throughout every phase of their adoption and use of Siebel Business Applications.
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 services 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.
Improvement of Our Operating Performance
In July 2004 we announced an operating performance improvement plan (the "Improvement Plan"), which we believe will help us return our operations to sustainable revenue growth and expand our operating margins. As part of the Improvement Plan we have been reviewing and continue to review our business thoroughly, with our primary focus in the following three areas: revenue generation, financial structure and leadership. A summary of the key elements of our Improvement Plan is included in Item 7 of our annual report on Form 10-K for the year ended December 31, 2004. We intend to further refine this plan in 2005 to further address our revenue generation capabilities and better align our financial structure with current revenue levels.
While we believe we are making progress towards achieving the objectives of the Improvement Plan, we clearly took a step back in the first quarter of 2005. After experiencing solid improvement in many of our key financial metrics during the third and fourth quarters of 2004, we underperformed in the first quarter of 2005, with our software license revenues declining by $51.8 million, or 41%, from $126.8 million in the first quarter of 2004 to $75.0 million in the first quarter of 2005. While there are numerous factors that we believe may have contributed to the shortfall in our license revenues in the first quarter, we recognize that our execution was the primary factor.
We intend to improve our revenue generation capabilities and are committed to improving our execution and delivering more consistent growth. Some of the challenges that we faced during the first quarter of 2005—challenges we must address and are addressing—include:
We experienced an increase in the number of approvals required by our customers prior to their execution of a software license and service agreement, possibly due to our customers' efforts regarding Section 404 of the Sarbanes-Oxley Act of 2002, or SOX. These more stringent governance and purchasing requirements lengthened the purchasing cycle. Accordingly, our close ratio in the first quarter of 2005 was lower than we have typically achieved and anticipated.
Many of our customers' and potential customers' budgeting processes were delayed during the first quarter of 2005, resulting in a delay of our customers' purchasing decisions. As a result, we believe the first quarter of 2005 was more seasonal than we had expected.
Several transactions slipped into the second quarter and second half of the year. It is important to note that we have since closed some of this business.
We have added many new members to our management team in recent months who are still learning our business processes and products, while simultaneously engaging new and existing customers. Despite this initial learning curve, we believe our new leadership team has put the right plan in place to grow our business and we expect to see tangible benefits from their expertise in the near future.
We are taking immediate steps to remedy the setback that we experienced in the first quarter of 2005 and we are confident that we will be successful in our endeavors. For example, we have or intend to:
Implement a new account planning and customer engagement model. The focus of this model is on growing the size and quality of our pipeline for the second half of the year and beyond.
Ensure that our entire executive management team's primary focus is on monitoring and closing business.
Revitalize our partners and alliance program. Historically, we have found these relationships to be enormously important in building the size and quality of our pipeline.
Launch a new marketing campaign and message—"it's all about the customer"—which communicates our commitment to customer value.
Simplify our sales management and organization structure to promote clarity, responsiveness and accountability.
Notwithstanding the setback in our quest to improve our revenue generation capabilities, we believe the underlying demand for our products exists. The shortfall in our results was largely a result of addressable execution issues. We intend to address our execution issues and will take action to improve our profitability until we see improving core software license revenue or sufficient offsetting growth in other areas of our business. Specifically to improve our profitability at the current revenue levels and to allow for expansion of margins as revenues improve, we intend to implement additional cost control measures. In the first phase of our new cost control initiatives, we intend to reduce discretionary sales, marketing and general and administrative spending, including selective reductions in personnel. In the second phase of our cost control initiatives, we plan to optimize and reprioritize our development projects and resources such that we focus on areas that represent growth opportunities and have shown growth in the last few quarters. Likewise, we are going to review our investments in some of the less promising geographic areas that are not showing positive results. We expect that these actions will improve operating margins in the second quarter and beyond.
Despite the shortfall in our software license revenues, there were a number of positive areas in our business during the first quarter of 2005. Professional services and other revenues increased by $13.8 million or 16%, from $87.6 million during the first quarter of 2004 to $101.4 million during the first quarter of 2005. Maintenance renewals remained very solid during the quarter at nearly 90%, with maintenance revenues growing by 7% from $114.9 million in the first quarter of 2004 to $122.6 million in the first quarter of 2005. Our OnDemand total contract value was approximately $11.2 million as of March 31, 2005, up over 250% compared to the same period in 2004, and the number of subscribers increased on a year-over-year basis by 16,600, nearly doubling. Our latest version of CRM OnDemand has recently been recognized by a leading research firm as a leader in hosted CRM capability. Our small and medium-sized business ("SMB") initiative—introduced in the second half of 2004 as part of our Improvement Plan—exceeded our goals. Finally, the number of live users of our software increased by nearly 300,000 during the first quarter of 2005 to 3.2 million users.
Summary of Our Operating Results for 2004 and Certain Key Financial Metrics
The following is a brief summary of our key financial metrics and operating results for the three months ended March 31, 2004 and 2005 (in thousands, except EPS, percentages and DSO):
Three Months Ended March 31,
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2004 2005
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Revenues:
Software license................................... $ 126,799 $ 74,978
Maintenance........................................ 114,877 122,578
Professional services and other.................... 87,611 101,382
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Total revenues................................ $ 329,287 $ 298,938
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Annualized total revenue per employee.............. $ 269 $ 232
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Cost and expenses:
Restructuring and acquisition-related expenses (1). $ 571 $ 11,382
All other costs and expenses, on-going (2)......... 292,151 309,471
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Total costs and expenses....................... $ 292,722 $ 320,853
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Other key operating statistics:
Operating income (loss)............................ $ 36,565 $ (21,915)
Operating margin................................... 11% (7)%
Earnings (loss) per share, diluted ("EPS")......... $ 0.06 $ (0.01)
Cash flows from operations......................... $ 89,799 $ 47,917
December 31, March 31,
2004 2005
---------------- ----------------
Balance sheet statistics:
Cash and short-term investments.................... $ 2,246,488 $ 2,196,276
Deferred revenue................................... $ 357,223 $ 365,979
Days sales outstanding ("DSO")..................... 67 77
Working capital.................................... $ 1,866,869 $ 1,827,059
Total stockholders' equity......................... $ 2,246,644 $ 2,293,590
Please refer to "Restructuring and Related Expenses" and "Purchased In-Process Product Development" in the following pages for a further discussion of these expenses.
Represents the sum of (i) total cost of revenues, (ii) product development expense, (iii) sales and marketing expense and (iv) general and administrative expense. We believe these expenses are more representative of our on-going operations.
Software license revenues
To illustrate this increase in seasonality, our software license revenues declined sequentially by 53% in the first quarter of 2005 from the fourth quarter of 2004, compared to a 16% sequential decline in the first quarter of 2004. We believe the decline from the fourth quarter of 2004 to the first quarter of 2005 is comparable to the historical trends of our competitors and more mature software companies.
Maintenance revenues
Professional services and other revenues,
Annualized total revenue per employee
Total costs and expenses
Operating income
Cash and short-term investments
Accounts receivable
Deferred revenues,
Working capital
Stockholders' equity
Outlook
Our outlook for the second quarter of 2005 discussed below is based, in part, on our review of our current sales pipeline, internal sales forecasts, recent surveys among information technology executives and current economic indicators. For the second quarter of 2005, we currently anticipate that our total revenues will be between $310 million and $330 million. We expect the individual components of our total revenues to be within the following ranges:
Our expectations regarding our revenues and ability to execute against those expectations may be negatively impacted by many factors, including (i) a deterioration in global economic conditions and/or information technology spending; (ii) a continued lengthening of our sales cycle and/or reduction in our sales pipeline; (iii) additional terrorist attacks or threats of terrorist attacks; (iv) geopolitical uncertainties, including continued hostilities involving the United States; (v) corporate and consumer confidence in the economy, as evidenced, in part, by the levels of the stock market; (vi) continued intense competition, including new technological innovations within our industry; (vii) the uncertainty in the application software industry and resulting reductions in capital expenditures; (viii) the loss of or inability to hire enough key employees and attrition in general; and (ix) other factors, including those described under "Risk Factors" below.
We expect total costs and expenses in the second quarter of 2005 to approximate the levels in the first quarter, primarily due to the additional cost controls discussed previously. Our expectations regarding our total costs and expenses are prior to costs associated with employee separations, including the costs discussed in Note 8 to the accompanying unaudited consolidated financial statements, and any other restructuring-related costs that may be incurred, if any. We expect these cost savings to be offset by (i) an increase in expenses that vary directly with revenues, such as "cost of professional services revenues," incentive compensation and commissions, and (ii) increases in personnel-related costs (i.e., salaries) associated with merit increases that were effective April 1, 2005.
As discussed further in Note 3 to the accompanying consolidated financial statements, certain of our U.S. payroll tax returns, U.S. sales and use tax returns and international sales and valued added tax returns are currently under examination and/or review by the applicable taxing authorities. While we believe that we have made adequate provisions related to the audits of these tax returns, the final determination of our obligations may exceed the amounts provided for by us. Specifically, we may receive assessments related to the audits and/or reviews of these tax returns that exceed amounts provided for by us. In the event we are unsuccessful in reducing the amount of such assessments, our estimates related to our total costs and expenses could be adversely affected.
As a result of the anticipated increases in our total revenue levels, we currently expect operating income and margin to increase in the second quarter of 2005 from levels obtained in first quarter. Our expectations regarding operating income depend in large part on our ability to grow our software license and professional services revenues.
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 potential transactions, 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. 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 we expect that a substantial portion of our software license contracts will continue to close in the latter part of a quarter, management would 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 or results of operations.
We expect other income, net for the second quarter of 2005 to be between approximately $13.0 million and $15.0 million.
We currently expect our effective tax rate for the second quarter of 2005 to be approximately 35%. 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 consolidated financial statements, our U.S. Federal income tax returns for 2001 through 2003 are currently under examination by the Internal Revenue Service ("IRS"). While the final resolution of the IRS's on-going 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 for 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, 2004 and 2005
Revenues
Our total revenues decreased from $329.3 million during the three months ended March 31, 2004 to $298.9 million during the three months ended March 31, 2005, representing a year-over-year decline of 9%. Our total revenues decreased during 2005 primarily due to a $51.8 million decrease in our software license revenues, partially offset by an increase of $21.5 million in our professional services, maintenance and other revenues. In order to provide a better understanding of the year-over-year changes and underlying trends in our revenues, 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, both in absolute dollars and as a percentage of total revenues, for the three months ended March 31, 2004 and 2005 (in thousands, except percentages):
Three Months Ended March 31,
-----------------------------------------
2004 2005 Change %
---------- ---------- ---------- ------
Software license revenues............ $126,799 $ 74,978 $ (51,821) (41)%
Percentage of total revenues......... 38% 25%