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Previous: BIG CITY BAGELS INC, NT 10-Q, 1999-11-15 |
Next: PRIMUS TELECOMMUNICATIONS GROUP INC, 10-Q, 1999-11-15 |
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
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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1855 South Grant Street
San Mateo, CA 94402
(Address of principal executive offices)
(650) 295-5000
(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 reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
The number of shares outstanding of the registrant's common stock, par value
$.001 per share, as of November 4, 1999, was 94,530,886.
SIEBEL SYSTEMS, INC.
FORM 10-Q
For the Quarterly Period Ended September 30, 1999
Table of Contents
Part I. Financial Information
Item 1. Financial Statements
a) Consolidated Balance Sheets as of September 30, 1999 and December 31, 1998
c) Consolidated Statements of Cash Flows for the nine months ended September 30, 1999 and 1998
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 4: Submission of Matters to a Vote of Security Holders
Item 6. Exhibits and Reports on Form 8-K
Part I. Financial Information
Item 1. Financial Statements
SIEBEL SYSTEMS, INC.
Consolidated Balance Sheets
(in thousands, except per share data; unaudited)
September 30, December 31,
1999 1998
------------ ------------
Assets
Current assets:
Cash and cash equivalents......................... $466,029 $79,961
Short-term investments............................ 158,593 151,888
Marketable equity securities...................... 46,503 --
Accounts receivable, net.......................... 213,664 122,818
Deferred income taxes............................. 13,120 13,120
Prepaids and other................................ 19,649 13,908
------------ ------------
Total current assets............................ 917,558 381,695
Property and equipment, net.......................... 43,500 45,537
Other assets......................................... 19,820 14,714
------------ ------------
Total assets.................................... $980,878 $441,946
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable.................................. $15,415 $3,899
Accrued expenses.................................. 105,725 84,917
Income taxes payable.............................. 9,986 10,917
Deferred revenue.................................. 63,259 50,875
Deferred income taxes............................. 15,356 --
------------ ------------
Total current liabilities....................... 209,741 150,608
Convertible subordinated debentures.................... 300,000 --
Deferred income taxes................................ 243 710
------------ ------------
Total liabilities............................... 509,984 151,318
------------ ------------
Stockholders' equity:
Common stock; $0.001 par value; 300,000
shares authorized; 93,202 and 89,630 shares
issued and outstanding, respectively.............. 93 90
Additional paid-in capital......................... 312,881 235,302
Notes receivable from stockholders................. (406) (406)
Deferred compensation.............................. (748) (360)
Accumulated other comprehensive income (losses).... 25,208 (669)
Retained earnings.................................. 133,866 56,671
------------ ------------
Total stockholders' equity...................... 470,894 290,628
------------ ------------
Total liabilities and stockholders' equity...... $980,878 $441,946
============ ============
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 Nine Months Ended
September 30, September 30,
------------------- -------------------
1999 1998 1999 1998
--------- --------- --------- ---------
Revenues:
Software............................... $125,951 $77,225 $329,388 $200,567
Professional services, maintenance
and other............................. 69,366 26,969 164,395 67,815
--------- --------- --------- ---------
Total revenues..................... 195,317 104,194 493,783 268,382
--------- --------- --------- ---------
Cost of revenues:
Software............................... 1,510 993 5,111 4,295
Professional services, maintenance
and other............................. 46,942 16,698 105,620 42,730
--------- --------- --------- ---------
Total cost of revenues............. 48,452 17,691 110,731 47,025
--------- --------- --------- ---------
Gross margin....................... 146,865 86,503 383,052 221,357
Operating expenses:
Product development.................... 16,532 11,572 50,160 30,862
Sales and marketing.................... 71,037 47,242 183,595 122,163
General and administrative............. 12,342 6,915 31,949 17,724
Merger related expenses................ -- -- -- 13,500
--------- --------- --------- ---------
Total operating expenses........... 99,911 65,729 265,704 184,249
--------- --------- --------- ---------
Operating income................... 46,954 20,774 117,348 37,108
Other income, net........................ 2,804 1,548 7,158 4,476
--------- --------- --------- ---------
Income before income taxes......... 49,758 22,322 124,506 41,584
Income taxes............................. 19,655 8,259 47,311 18,583
--------- --------- --------- ---------
Net income ........................ $30,103 $14,063 $77,195 $23,001
========= ========= ========= =========
Diluted net income per share............. $0.27 $0.14 $0.71 $0.23
========= ========= ========= =========
Shares used in diluted net income
per share computation................... 111,196 100,348 108,703 99,765
========= ========= ========= =========
Basic net income per share............... $0.32 $0.16 $0.84 $0.26
========= ========= ========= =========
Shares used in basic net income
per share computation................... 92,761 88,048 91,517 87,075
========= ========= ========= =========
Comprehensive income (loss):
Net income ........................ $30,103 $14,063 $77,195 $23,001
Other comprehensive income (loss),
net of tax:
Foreign currency translation
adjustments................... 465 224 726 (138)
Unrealized gains (losses) on
available-for-sale securities. (10,213) -- 25,151 --
--------- --------- --------- ---------
Other comprehensive income (loss)........ (9,748) 224 25,877 (138)
--------- --------- --------- ---------
Total comprehensive income (loss).. $20,355 $14,287 $103,072 $22,863
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
SIEBEL SYSTEMS, INC.
Consolidated Statements of Cash Flows
(in thousands; unaudited)
Nine Months Ended
September 30,
----------------------
1999 1998
---------- ----------
Cash flows from operating activities:
Net income............................................ $77,195 $23,001
Adjustments to reconcile net income to net cash
provided by operating activities:
Compensation related to stock options............. 151 193
Depreciation and amortization..................... 14,899 7,969
Loss on disposal of property and equipment........ 714 242
Provision for doubtful accounts and returns....... 4,938 3,964
Changes in operating assets and liabilities:
Accounts receivable............................. (95,784) (50,454)
Prepaids and other.............................. (5,741) (563)
Accounts payable................................ 11,516 1,377
Accrued expenses................................ 20,808 41,930
Income taxes payable............................ 32,644 5,010
Deferred revenue................................ 12,384 23,139
---------- ----------
Net cash provided by operating activities..... 73,724 55,808
---------- ----------
Cash flows from investing activities:
Purchases of property and equipment................... (24,919) (15,837)
Proceeds from sale of property and equipment.......... 13,225 --
Purchases of short-term investments................... (78,437) (92,922)
Sales and maturities of short-term investments........ 70,937 64,583
Other assets.......................................... (3,739) 2,514
---------- ----------
Net cash used in investing activities......... (22,933) (41,662)
---------- ----------
Cash flows from financing activities:
Proceeds from issuance of convertible
subordinated debentures............................. 300,000 --
Payment of debt issuance costs........................ (8,250) --
Proceeds from issuance of common stock................ 43,527 25,492
---------- ----------
Net cash provided by financing activities..... 335,277 25,492
---------- ----------
Change in cash and cash equivalents...................... 386,068 39,638
Adjustment to conform acquired company's year end........ -- (4,140)
Cash and cash equivalents, beginning of period........... 79,961 70,202
---------- ----------
Cash and cash equivalents, end of period................. $466,029 $105,700
========== ==========
Supplemental disclosures of cash flow information:
Cash paid for income taxes.............................. $14,667 $3,154
========== ==========
Tax benefit from exercise of stock options.............. $33,575 $8,061
========== ==========
See accompanying notes to consolidated financial statements.
SIEBEL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Summary of Significant Accounting Policies
The accompanying unaudited consolidated financial statements have been prepared on substantially the same basis as the audited consolidated financial statements, and in the opinion of management 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, 1999.
In May 1998, Siebel Systems, Inc. (the "Company") acquired Scopus Technology, Inc. ("Scopus") in a merger transaction accounted for as a pooling of interests. Accordingly, all financial information has been restated to reflect the combined operations of the two companies. See Note 2.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated.
Revenue Recognition
The Company recognizes revenue in accordance with Statement of Position ("SOP") 97-2 "Software Revenue Recognition." Revenue from software licenses is recognized under SOP No. 97-2 when persuasive evidence of an arrangement exists and delivery has occurred, provided the fee is fixed and determinable, collectibility is probable and the arrangement does not require significant customization of the software. Revenue on multiple element arrangements is allocated to the various elements based on fair values specific to the Company.
Professional services, maintenance and other revenues relate primarily to consulting services, maintenance and training. Maintenance revenues are recognized ratably over the term of the maintenance contract, typically 12 months. Consulting and training revenues are recognized as the services are performed and are usually on a time and materials basis. Such services primarily consist of implementation services related to the installation of the Company's products and do not include significant customization to, or development of, the underlying software code.
Cost of Revenues
Cost of software consists primarily of media, product packaging, documentation and other production costs, and third-party royalties.
Cost of professional services, maintenance and other consists primarily of salaries, benefits and allocated overhead costs related to consulting, training and customer support personnel, including cost of services provided by third party consultants engaged by the Company.
Use of Estimates
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents, Short-Term Investments and Marketable Equity Securities
The Company considers all highly liquid investments with a remaining maturity of 90 days or less at the date of purchase to be cash equivalents. Short-term investments generally consist of highly liquid debt securities with remaining maturities in excess of 90 days. Marketable equity securities include an investment in a publicly traded company. The Company has classified its short-term investments and marketable equity securities as "available-for-sale." Such investments are carried at fair value with unrealized gains and losses, net of related tax effects, reported within accumulated other comprehensive income. Realized gains and losses on available-for-sale securities are computed using the specific identification method.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is calculated using the straight-line method over the estimated useful lives of the respective assets, generally three to five years. Leasehold improvements are amortized over the lesser of the lease term or the estimated useful lives of the improvements, generally seven years.
Software Development Costs
Software development costs associated with new products and enhancements to existing software products are expensed as incurred until technological feasibility in the form of a working model has been established. To date, the time period between the establishment of technological feasibility and completion of software development has been short, and no significant development costs have been incurred during that period. Accordingly, the Company has not capitalized any software development costs to date.
Intangible Assets
Included in other assets are various intangible assets, primarily goodwill related to acquisitions. These amounts are being amortized over a three-year period using the straight-line method. Gross intangible assets were $7,680,000 and $7,162,000 at September 30, 1999 and December 31, 1998, respectively, and the related accumulated amortization was $2,634,000 and $800,000 at September 30, 1999 and December 31, 1998, respectively.
Advertising
Advertising costs are expensed as incurred. Advertising expense is included in sales and marketing expense and amounted to $16,735,000 and $6,324,000 for the nine months ended September 30, 1999 and 1998, respectively.
Income Taxes
The Company uses the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets are recognized for deductible temporary differences, net operating loss carryforwards and credit carryforwards if it is more likely than not that the tax benefits will be realized. To the extent a deferred tax asset cannot be recognized under the preceding criteria, allowances must be established. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.
Net Income Per Share
Basic earnings per share is computed using the weighted average number of shares of common stock outstanding. Diluted earnings per share is computed using the weighted average number of shares of common stock and, when dilutive, common equivalent shares from options to purchase common stock and warrants outstanding using the treasury stock method. Diluted earnings per share also gives effect, when dilutive, to the conversion of the convertible subordinated debentures, using the if- converted method.
Employee Stock Option and Purchase Plans
The Company accounts for its stock-based compensation plans using the intrinsic value method. As such, compensation expense is recorded on the date of grant if the current market price of the underlying stock exceeds the exercise price.
Foreign Currency Translation
The Company considers the functional currency of its foreign subsidiaries to be the local currency, and accordingly, the financial statements of the foreign subsidiaries are translated into U.S. dollars using exchange rates in effect at period end for assets and liabilities and average exchange rates during each reporting period for the results of operations. Adjustments resulting from translation of foreign subsidiary financial statements are reported within accumulated other comprehensive income. To date, the related tax effects have not been significant.
The Company generally utilizes foreign currency forward contracts to hedge its exchange risk on foreign currency receivable and intercompany balances. While these forward contracts are subject to fluctuations in value, which are recorded in current results of operations, such fluctuations are generally offset by the changes in value of the underlying exposures being hedged. The Company does not hold or issue financial instruments for speculative or trading purposes.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to a concentration of credit risk principally consist of trade accounts receivable. The Company performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable, as the majority of the Company's customers are large, well established companies. The Company maintains reserves for potential credit losses, but historically has not experienced any significant losses related to any particular industry or geographic area since the Company's business is not concentrated on any one particular customer or customer base. No single customer accounts for more than 10% of revenues; and the Company's largest customer base, high technology, which accounted for approximately 24% of revenues during the nine months ended September 30, 1999, is sufficiently broad that the Company does not consider itself significantly exposed to concentrations of credit risk.
Fair Value of Financial Instruments
The carrying amounts of the Company's cash and cash equivalents, short-term investments, accounts receivable, and accounts payable approximate their respective fair values. Changes in the fair value of the Company's derivative financial instruments (foreign currency forward contracts) are generally offset by changes in the value of the underlying exposures being hedged. The fair value of the Company's derivative financial instruments at September 30, 1999 was a loss of approximately $882,000.
Impairment of Long-Lived Assets
The Company evaluates long-lived assets, including goodwill, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset. The amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. The Company does not have any long-lived assets it considers to be impaired.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated and accounted for as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. For a derivative not designated as a hedging instrument, changes in the fair value of the derivative are recognized in earnings in the period of change. This statement will be effective for all annual and interim periods beginning after June 15, 2000. Management does not believe the adoption of SFAS No. 133 will have a material effect on the Company's consolidated financial position or results of operations.
In December 1998, the Accounting Standards Executive Committee (AcSEC) of the AICPA issued SOP 98-9, "Software Revenue Recognition with Respect to Certain Arrangements", which requires recognition of revenue using the "residual method" in a multiple element arrangement when fair value does not exist for one or more of the undelivered elements in the arrangement. Under the "residual method", the total fair value of the undelivered elements is deferred and subsequently recognized in accordance with SOP 97-2. Management does not believe the adoption of SOP 98-9 will have a material effect on the Company's consolidated financial position or results of operations. SOP 98-9 will be effective for the Company for all annual and interim periods beginning on and after January 1, 2000.
2. Scopus Merger
In May 1998, the Company completed the acquisition of Scopus, a leading provider of customer service, field service, and call center software solutions. Under the terms of the agreement, each outstanding share of Scopus common stock was exchanged for newly issued shares of common stock of the Company. This resulted in the issuance of approximately 15.1 million additional shares of the Company's Common Stock. In addition, all outstanding stock options of Scopus were converted into the right to acquire the Company's Common Stock at the same exchange ratio with a corresponding adjustment to the exercise price. In connection with the merger, the Company incurred direct merger- related expenses of approximately $13,500,000 consisting of direct transaction fees for investment bankers, attorneys, accountants and other professional fees of $9,100,000, integration charges related to duplicate facilities and equipment of $3,100,000 and other miscellaneous expenses of $1,300,000. The Company also incurred indirect merger-related expenses of approximately $1,800,000 for joint sales training and merger- related marketing costs, which are included within sales and marketing expenses.
The transaction has been accounted for as a pooling of interests. Accordingly, the financial statements of Siebel have been restated to include the financial position and results of operations of Scopus for all periods presented. Prior to the merger with Siebel, Scopus ended its fiscal year on March 31. The restated financial statements as of December 31, 1997, and for prior periods, include Siebel's results of operations for those periods and Scopus' results of operations for the fiscal period ending three months later. Beginning January 1, 1998, the reporting periods of Siebel and Scopus were conformed, and results of operations were combined for the calendar periods presented.
The results of operations for the separate companies and the combined amounts presented in the consolidated financial statements follow (in thousands, unaudited):
Three months
ended
March 31,
(in thousands, unaudited) 1998
------------
Total revenues:
Siebel..................... $47,100
Scopus..................... 27,072
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$74,172
============
Net income:
Siebel..................... $8,284
Scopus..................... 1,464
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$9,748
============
3. Net Income Per Share
The following is a reconciliation of the number of shares used in the basic and diluted earnings per share computations for the periods presented (in thousands, unaudited):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
(in thousands, unaudited) 1999 1998 1999 1998
--------- --------- --------- ---------
Shares used in basic net income
per share computation................... 92,761 88,048 91,517 87,075
Effect of dilutive potential common
shares.................................. 18,435 12,300 17,186 12,690
--------- --------- --------- ---------
Shares used in diluted net income
per share computation................... 111,196 100,348 108,703 99,765
========= ========= ========= =========
The Company excludes potentially dilutive securities from its diluted net income per share computation when either the exercise price of the securities exceeds the average fair value of the Company's common stock for the period or the Company reported net losses during the period because their effect would be anti-dilutive. For the nine months ended September 30, 1999, the Company excluded 1,476,130 employee stock options with a weighted average exercise price of $58.98 per share from the earnings per share computation as their exercise prices exceeded the average fair value of the Company's common stock during such period and, accordingly, their inclusion would have been anti-dilutive. For the three and nine months ended September 30, 1998, the Company excluded 1,878,161 and 2,640,541 employee stock options, respectively, with a weighted average exercise price of $30.42 and $29.36 per share, respectively, from the earnings per share computation. For the three months ended September 30, 1999, the Company did not exclude any employee stock options from the earnings per share computation as the average fair value of the Company's common stock during such period exceeded their exercise prices. For the three and nine months ended September 30, 1999, the Company excluded the convertible subordinated debentures from the earnings per share computation as the effect would be antidilutive.
4. Segment and Geographic Information
The Company and its subsidiaries are principally engaged in the design, development, marketing and support of Siebel Front Office Applications, its family of proprietary software applications. Substantially all revenues result from the licensing of the Company's software products and related consulting and customer support (maintenance) services. The Company's chief operating decision maker 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 industry segment, specifically the license, implementation and support of its software applications.
5. Commitments and Contingencies
In March 1999, the Company entered into a security agreement with a bank to collateralize certain letters of credit issued by the bank on behalf of the Company. Letters of credit for $8,400,000, expiring October 2001, have been issued under this agreement.
6. Convertible Subordinated Notes
The Company completed a private placement of $300,000,000 of convertible subordinated notes in September 1999. The seven-year term notes bear interest at a rate of 5.50 percent per annum and are convertible into shares of the Company's common stock at any time prior to maturity at a conversion price of approximately $93.27 per share, subject to adjustment under certain conditions. The notes may be redeemed, in whole or in part, by the Company at any time on or after September 15, 2002. The redemption price will range from $309,420,000 to $302,370,000 if the notes are redeemed between September 15, 2002 through September 14, 2006. Any redemption made on or after September 15, 2006 will be redeemed at $300,000,000. Accrued interest to the redemption date will be paid by the Company in each redemption.
7. Subsequent Event
Stock Split
On August 24, 1999 and October 20, 1999, respectively, the Company's Board of Directors and stockholders approved a two-for-one stock split (to be effective in the form of a stock dividend) to be paid on November 12, 1999. The accompanying consolidated financial statements do not give effect to the pending stock split.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The statements contained in this Quarterly Report on Form 10-Q (the "Report") that are not historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), including statements regarding the Company's expectations, beliefs, intentions or strategies regarding the future. Forward-looking statements include, without limitation, statements regarding the extent and timing of future revenues and expenses and customer demand, statements regarding the deployment of the Company's products, and statements regarding reliance on third parties. All forward-looking statements included in this document are based on information available to the Company as of the date hereof, and the Company assumes no obligation to update any such forward-looking statement. It is important to note that the Company's actual results could differ materially from those in such forward-looking statements.
Overview
Siebel Systems, Inc. ("Siebel" or the "Company") is the world's leading supplier of Web-based front office software systems. Siebel provides an integrated family of sales, marketing and customer service application software for field sales, customer service, telesales, telemarketing, field service, third-party resellers and Internet-based eBusiness. Siebel Systems' products are designed to meet the needs of small, medium and large businesses.
In today's increasingly competitive global markets, businesses must continuously improve their operations. Having spent considerable effort and resources in previous years automating finance, manufacturing, distribution, human resources management, and general office operations, many businesses are now looking to apply the leverage of information technology to their sales, marketing and customer service processes. Unlike previous automation efforts which have focused on decreasing expenses, sales, marketing and customer service information systems focus primarily on increasing revenues and customer satisfaction.
The Siebel Front Office Applications are comprised of a broad range of advanced Web-based application software products designed to allow corporations to deploy comprehensive sales, marketing and customer service information systems on a global basis. The Company's products provide support for a number of frequently interdependent distribution channels, including direct field sales, telesales, telemarketing, retail, customer service, call centers, field service, resellers, business partners and Internet-based e-commerce, marketing and customer service. The Company's products provide support for a broad range of industries, business practices and multiple languages and currencies.
Results of Operations
Revenues
Software. License revenues increased to $125,951,000 for the three months ended September 30, 1999 from $77,225,000 for the three months ended September 30, 1998 and decreased as a percentage of total revenues to 64% in the third quarter 1999 from 74% in the third quarter 1998. License revenues increased to $329,388,000 for the nine months ended September 30, 1999 from $200,567,000 for the nine months ended September 30, 1998 and decreased as a percentage of total revenues to 67% in the fiscal 1999 period from 75% in the fiscal 1998 period. License revenues increased in absolute dollars during this period as compared to the respective prior period due to an increase in the number of licenses of Siebel applications sold to new and existing customers and also due to licenses of new modules, released with the latest version of Siebel applications, sold to existing users of Siebel base applications. The increase in the number of licenses was primarily due to continued demand by new and existing customers for products in the Siebel applications family both in the United States and internationally. The Company expects that license revenues will remain the same or decrease as a percentage of total revenues as the Company's maintenance revenues continue to grow as a result of increases in the installed base of customers receiving maintenance and due to the Company's expansion of its consulting organization to meet anticipated customer demands in connection with product implementation.
Professional Services, Maintenance and Other. Professional services, maintenance and other revenues increased to $69,366,000 for the three months ended September 30, 1999 from $26,969,000 for the three months ended September 30, 1998 and increased as a percentage of total revenues to 36% in the third quarter of 1999 from 26% in the third quarter of 1998. Professional services, maintenance and other revenues increased to $164,395,000 for the nine months ended September 30, 1999 from $67,815,000 for the nine months ended September 30, 1998 and increased as a percentage of total revenues to 33% in the fiscal 1999 period from 25% in the fiscal 1998 period. The increase in the absolute dollar amount was primarily due to growth in the Company's consulting business and growth in the installed base of customers with a maintenance contract. First-year maintenance is typically sold with the related software license. Revenue related to such maintenance is deferred based on vendor-specific objective evidence of fair value and amortized over the term of the maintenance contract, typically 12 months. The Company expects that professional services, maintenance and other revenues will remain the same or increase as a percentage of total revenues due to increased maintenance revenues derived from the Company's growing installed base and due to the Company's expansion of its consulting organization to meet anticipated customer demands in connection with product implementation.
The Company markets its products in the United States through its direct sales force and internationally through its sales force and through distributors which are primarily in Japan, Europe, Latin America, South Africa and Asia. International revenues accounted for 31% and 29% of license revenues for the nine months ended September 30, 1999 and 1998, respectively. The Company is increasing its international sales force and is seeking to establish distribution relationships with appropriate strategic partners and expects international revenues will continue to account for a substantial portion of total revenues in the future.
Cost of Revenues
Software. Cost of software license revenues includes third party software royalties, product packaging, documentation and production. Cost of license revenues increased to $1,510,000 for the three months ended September 30, 1999 from $993,000 for the three months ended September 30, 1998. Cost of license revenues increased to $5,111,000 for the nine months ended September 30, 1999 from $4,295,000 for the nine months ended September 30, 1998. Cost of license revenues as a percentage of total revenues was less than 3% for each of the nine month periods and three month periods ended September 30, 1999 and 1998. All costs incurred in the research and development of software products and enhancements to existing products have been expensed as incurred, and, as a result, cost of license revenues includes no amortization of capitalized software development costs. These costs are expected to remain the same or increase as a percentage of total revenues.
Professional Services, Maintenance and Other. Cost of professional services, maintenance and other revenues consists primarily of personnel, facilities and systems costs incurred in providing consulting and customer support. Cost of professional services, maintenance and other revenues increased to $46,942,000 for the three months ended September 30, 1999 from $16,698,000 for the three months ended September 30, 1998 and increased as a percentage of total revenues to 24% in the fiscal 1999 period from 16% in the fiscal 1998 period. Cost of professional services, maintenance and other revenues increased to $105,620,000 for the nine months ended September 30, 1999 from $42,730,000 for the nine months ended September 30, 1998 and increased as a percentage of total revenues to 21% in the fiscal 1999 period from 16% in the fiscal 1998 period. The increase in the absolute dollar amount reflects the effect of fixed costs resulting from the Company's expansion of its maintenance and support organization and growth in the Company's consulting business. The Company expects that professional services, maintenance and other costs will continue to increase in absolute dollar amount as the Company expands both its customer support organization to support a growing installed base and its consulting organization to meet anticipated customer demands in connection with product implementation. These costs are expected to remain the same or increase as a percentage of total revenues.
Operating Expenses
Product Development. Product development expenses include expenses associated with the development of new products, enhancements of existing products and quality assurance activities, and consist primarily of employee salaries, benefits, consulting costs and the cost of software development tools. Product development expenses increased to $16,532,000 for the three months ended September 30, 1999 from $11,572,000 for the three months ended September 30, 1998 and decreased as a percentage of total revenues to 8% in the fiscal 1999 period from 11% in the fiscal 1998 period. Product development expenses increased to $50,160,000 for the nine months ended September 30, 1999 from $30,862,000 for the nine months ended September 30, 1998 and decreased as a percentage of total revenues to 10% in the fiscal 1999 period from 11% in the fiscal 1998 period. The increase in the absolute dollar amount of product development expenses was primarily attributable to costs of additional personnel in the Company's product development operations. The Company anticipates that it will continue to devote substantial resources to product development. The Company expects product development expenses to increase in absolute dollar amount but remain at a similar percentage of total revenues as in the first nine months of 1999. The Company considers technological feasibility of its software products to have been reached upon completion of a working model that has met certain performance criteria. The period between achievement of technological feasibility and general release of a software product is typically very short, and development costs incurred during that period have not been material. Accordingly, the Company has not capitalized any software development costs to date.
Sales and Marketing. Sales and marketing expenses consist primarily of salaries, commissions and bonuses earned by sales and marketing personnel, field office expenses, travel and entertainment and promotional expenses. Sales and marketing expenses increased to $71,037,000 for the three months ended September 30, 1999 from $47,242,000 for the three months ended September 30, 1998 and decreased as a percentage of total revenues to 36% in the fiscal 1999 period from 45% in the fiscal 1998 period. Sales and marketing expenses increased to $183,595,000 for the nine months ended September 30, 1999 from $122,163,000 for the nine months ended September 30, 1998 and decreased as a percentage of total revenues to 37% in the fiscal 1999 period from 46% in the fiscal 1998 period. The increase in the dollar amount of sales and marketing expenses reflects primarily the hiring of additional sales and marketing personnel and costs associated with expanded promotional activities. The Company expects that sales and marketing expenses will continue to increase in absolute dollars as the Company continues to expand its sales and marketing efforts, establishes additional sales offices in the United States and internationally and increases its promotional activities. These expenses are expected to remain at a similar percentage of total revenues as in the first nine months of 1999.
General and Administrative. General and administrative expenses consist primarily of salaries and occupancy costs for administrative, executive and finance personnel. General and administrative expenses increased to $12,342,000 for the three months ended September 30, 1999 from $6,915,000 for the three months ended September 30, 1998 and decreased as a percentage of total revenues to 6% in the fiscal 1999 period from 7% in the fiscal 1998 period. General and administrative expenses increased to $31,949,000 for the nine months ended September 30, 1999 from $17,724,000 for the nine months ended September 30, 1998 and decreased as a percentage of total revenues to 6% in the fiscal 1999 period from 7% in the fiscal 1998 period. The increase in the absolute dollar amount of general and administrative expenses was primarily due to increased staffing and associated expenses necessary to manage and support the Company's increased scale of operations. The Company believes that its general and administrative expenses will continue to increase in absolute dollars as a result of the continued expansion of the Company's administrative staff and facilities to support growing operations. The Company anticipates that its general and administrative expenses as a percentage of total revenues should remain at a similar percentage as in the first nine months of 1999.
Merger related expenses. In connection with the merger with Scopus, the Company incurred direct merger-related expenses of approximately $13,500,000 consisting of direct transaction fees for investment bankers, attorneys, accountants and other professional fees of $9,100,000, integration charges related to duplicate facilities and equipment of $3,100,000 and other miscellaneous expenses of $1,300,000. The Company also incurred indirect merger-related expenses of approximately $1,800,000 for joint sales training and merger-related marketing costs, which are included within sales and marketing expenses.
There were no significant merger-related expenses in the three and nine months ended September 30, 1999.
Operating Income and Operating Margin
Operating income increased to $46,954,000 for the three months ended September 30, 1999 from $20,774,000 for the three months ended September 30, 1998 and operating margin increased to 24% in the fiscal 1999 period from 20% in the fiscal 1998 period. For the nine months ended September 30, 1999 operating income increased to $117,348,000 from $37,108,000 for the nine months ended September 30, 1998 and operating margin increased to 24% in the fiscal 1999 period from 14% in the fiscal 1998 period. These increases in operating income and margin were primarily due to $13,500,000 of merger-related expenses incurred in the nine months ended September 30, 1998, not recurring in 1999. Excluding the merger-related expenses, operating income for the nine months ended September 30, 1999 increased to $117,348,000 from $50,608,000 for the nine months ended September 30, 1998 and operating margin increased to 24% in the fiscal 1999 period from 19% in the fiscal 1998 period. This increase in operating income and margin was due to increases in license revenues without a proportional increase in cost, particularly costs associated with the hiring of new personnel. The Company expects operating margins, net of merger-related expenses, to decrease as compared to operating margin for the first nine months of 1999 as it continues to invest heavily in sales, marketing, development and support activities globally.
Other Income, Net
Other income, net is primarily comprised of interest income earned on the Company's cash and cash equivalents and short-term investments and reflects earnings on increasing cash and cash equivalents and short-term investment balances.
Provision for Income Taxes
Income taxes are comprised primarily of federal and state taxes. The provision for income taxes was $19,655,000 and $8,259,000 or 39.5% and 37%, respectively, for the three months ended September 30, 1999 and 1998, respectively. The provision for income taxes was $47,311,000 and $18,583,000 or 38% and 45%, respectively, for the nine months ended September 30, 1999 and 1998, respectively. The effective tax rate in 1998 was affected by the non-deductibility of certain merger-related expenses. The Company expects its effective tax rate for the remainder of 1999 to be approximately 38%.
Net Income
The Company had net income of $30,103,000 for the three months ended September 30, 1999 compared to net income of $14,063,000 for the three months ended September 30, 1998. Diluted net income per share was $0.27 in the third quarter of 1999 compared to diluted net income per share of $0.14 in the comparable period in 1998. Net income was 15% as a percentage of total revenues for the three months ended September 30, 1999 compared to net income of 13% for the three months ended September 30, 1998. The Company had net income of $77,195,000 for the nine months ended September 30, 1999 compared to net income of $23,001,000 for the nine months ended September 30, 1998. Diluted net income per share was $0.71 in the third quarter of 1999 compared to net income per share of $0.23 in the comparable period in 1998. Net income increased as a percentage of total revenues to 16% in the nine months ended September 30, 1999 from 9% in the nine months ended September 30, 1998.
Liquidity and Capital Resources
The Company's cash, cash equivalents and short-term investments increased to $624,622,000 as of September 30, 1999 from $231,849,000 as of December 31, 1998, representing approximately 64% and 52% of total assets, respectively. This increase was primarily attributable to net income, increases in accounts payable, income taxes payable, accrued expenses, deferred revenue and the issuance of subordinated debentures and common stock under the Company's stock option plans, partially offset by an increase in accounts receivable and purchases of property and equipment. The Company's days sales outstanding (DSO) in accounts receivable was 98 as of September 30, 1999, compared with 90 as of December 31, 1998. The Company expects DSO to continue to fluctuate significantly in future quarters.
As of November 4, 1999, the fair market value of the Company's marketable equity securities was $71,986,000.
The Company recently entered into a lease agreement for a new headquarters facility in San Mateo, California. The Company expects to incur significant capital expenditures in connection with tenant improvements, funiture and fixtures for this facility. These expenditures are expected to be incurred through the end of 2000. In addition, the Company expects to continue to incur capital expenditures associated with tenant improvements, furniture and fixtures for newly-leased field offices.
Capital expenditures of the nature described above are expected to increase during the remainder of 1999 and 2000.
The Company believes that the anticipated cash flows from operations, cash, cash equivalents and short-term investments will be adequate to meet its cash needs for working capital and capital expenditures for at least the next twelve months.
Year 2000 Preparedness
Many existing computer programs and systems use only two-digit fields to identify the year, e.g. 85=1985, and they are unable to process date and time information between the twentieth and twenty-first centuries. Accordingly, computer programs and software may need to be modified prior to the year 2000 ("Y2K") in order to remain functional. Failure to complete the necessary modifications could cause a disruption or failure of such program and system.
The Company's Y2K initiative has been managed by a team of internal staff and third-party consultants specializing in Y2K issues. The team's activities are designed to identify potential Y2K problems and to ensure that there is no adverse effect on our core business operations and that transactions with clients, suppliers and financial institutions are fully supported. The Company's efforts have focused on three areas: (i) the Company's products, (ii) internal operating systems and (iii) interfaces with third-party systems.
o Products. The Company has put in place a certification program to verify the Y2K compliance of its products. Beginning with version 4.0 (Siebel 98), the Company's programs have been designed to be Y2K compliant. The Company has applied a number of test approaches and criteria to each of its products beginning with Siebel 98 and believes that all such products are Y2K compliant. While we believe that our currently developed and actively marketed products are Y2K compliant for significantly all functionality, our software products could contain errors or defects relating to Y2K. The Company has advised certain of its customers that internal testing of Y2K compliance should be conducted to ensure that the operations managed by Siebel products continue without disruption. If such modifications and conversions are not made, or are not completed in a timely manner, the Y2K issue could have a material adverse impact on our operations. The costs incurred to test the Company's products for Y2K compliance were incurred as normal product development expenses. Any additional expenses are expected to be minimal.
o Internal Operating Systems. The Company has implemented a plan to test all internal operating systems, such as computer hardware and software, telephone/PBX systems, fax machines, facilities systems such as building access and other miscellaneous systems on a worldwide basis. The Company has approached its Y2K internal readiness program in the following three phases: (i) assessment, (ii) planning and (iii) implementation. These phases included such individual steps as taking an inventory of the Company's operating systems prioritized by risk, identifying failure dates, defining a solution strategy, estimating repair costs, identifying specific tasks necessary to ensure readiness, determining resource requirements and allocations, and finally, testing and fixing the operating systems as well as putting in place contingency plans for operating systems that have a high impact on the Company's business. The plan has been executed and the Company does not believe that the Y2K issue will pose significant operational problems to our internal operating systems. Costs incurred to complete this process have not been material.
o Third-Party Systems. The Company has developed a Y2K process for dealing with its key suppliers, distributors, vendors, system integrators and other partners. The Company has been in contact with its key third-party relationships regarding their Y2K compliance. The Company has received responses from its critical third-party relationships, who have stated that they expect to address all of their significant Y2K issues in a timely manner. The Company is working to identify and analyze the most reasonably likely worst case scenarios for key third party relationships affected by Y2K. These scenarios could include possible infrastructure collapse, the failure of water and power supplies, major transportation disruptions and failures of communications or financial systems - any of which could have a material adverse effect on the Company's ability to deliver its products and services to its customers. While the Company has contingency plans in place to address most issues under its control, an infrastructure problem outside of its control could result in a delay in product shipments, depending on the nature and severity of the problems. The Company has analyzed its key third-party systems and believes all of them to be largely Y2K compliant. Costs incurred to complete this process have not been material.
Contingency plans. Our Y2K Program is designed to minimize the possibility of serious Year 2000 interruptions. However, since their possibility cannot be eliminated, we are developing contingency plans addressing Year 2000 concerns in high impact areas. These plans will continue to be reviewed and updated through out the end of the calendar year. Other contingency plans will be prepared, tested, and updated as deemed practicable and appropriate.
The Company currently believes that the most reasonably likely worst- case scenario is that there will be some Year 2000 disruptions at individual locations that could affect individual business processes, facilities or third parties for a short time. The Company does not expect such disruptions to be long-term, or for the disruptions to affect the operations of the Company as a whole. Because of the uncertainty as to the exact nature or location of potential Year 2000-related problems that might arise, the business continuity/contingency planning has focused on development of flexible plans to minimize the scope, impact and duration of any Year 2000 problems that may occur. The Company expects to have personnel and resources available to deal with any Year 2000 problems that occur. Some of the currently planned contingency actions include designating emergency response teams, increasing staffing at critical times, in particular the Year 2000 weekend, and heightening proactive monitoring at likely dates of impact.
Although the Company has spent a large amount of time and resource to address potential Y2K problems, there is no assurance that the Company will be successful in its efforts to identify and address all Y2K issues. Even though the Company has acted in a timely manner to complete all of its assessments and planned solutions, some problems may not have been identified or corrected in time to prevent material adverse consequences to the Company. The discussion above includes forward-looking statements regarding Y2K and is based on the Company's best estimates given information that is currently available and is subject to change. As the Company continues to progress with its Y2K initiatives, it may discover that actual results will differ materially from these estimates. See "Factors Affecting Operating Results -- Year 2000 Problems may cause an Interruption in our Business."
Factors Affecting Operating Results
A Limited Operating History Upon Which to Evaluate our Business. We began operations in July 1993. We first shipped our Siebel Sales Enterprise product in April 1995 and our Siebel Service Enterprise product in December 1996. Subsequent versions of these products were first shipped in 1996 and 1997. Accordingly, we have a limited operating history upon which you may evaluate our business and prospects. You should evaluate our prospects in light of the risks, expenses and uncertainties that companies in their early stage of development frequently encounter.
Net Revenue and Operating Results may Fluctuate. Our net revenue and operating results may fluctuate significantly because of a number of factors, many of which are outside of our control. These factors include:
o Level of product and price competition;
o Length of our sales cycle and customer purchasing patterns;
o The size and timing of individual license transactions;
o Delay or deferral of customer implementations of our products;
o Success in expanding our customer support organization,
direct sales force and indirect distribution channels;
o Timing of new product introductions and product enhancements;
o Appropriate mix of products and services sold;
o Levels of international sales;
o Activities of and acquisitions by competitors;
o Timing of new hires and the allocation of our resources;
o Changes in the economy and foreign currency exchange rates; and
o Our ability to develop and market new products and control costs.
One or more of the foregoing factors may cause our operating expenses to be disproportionately high during any given period or may cause our net revenue and operating results to fluctuate significantly. Based on the preceding factors, we may experience a shortfall in revenue or earnings or otherwise fail to meet public market expectations, which could materially adversely affect our business, financial condition and the market price of our common stock.
Quarterly Operating Results may Fluctuate. Our net revenue and operating results may vary drastically from quarter to quarter. The main factors, which may affect these fluctuations, are:
o The discretionary nature of our customer's purchase and budget cycles;
o The size and complexity of our license transactions;
o The potential delays in recognizing revenue from license transactions;
o The timing of new product releases;
o Seasonal variations in operating results; and
o Variations in the fiscal or quarterly cycles of our customers.
Each customer's decision to implement our products and services is discretionary, involves a significant commitment of resources and is subject to their budget cycles. In addition, the timing of license revenue is difficult to predict because of the length of our sales cycle, which has ranged to date from two to eighteen months. We base our operating expenses on anticipated revenue trends. Because a high percentage of these expenses are relatively fixed, a delay in recognizing revenue from license transactions could cause significant variations in operating results from quarter to quarter and could result in operating losses. If these expenses precede, or are not subsequently followed by, increased revenues, our operating results could be materially and adversely affected. Although we have not experienced significant seasonal variations in operating results, such variations could develop in the future.
As a result of these and other factors, revenues for any quarter are subject to significant variation, and we believe that period-to-period comparisons of our results of operations are not necessarily useful. You should not rely on these comparisons as indications of future performance. It is likely that our future quarterly operating results from time to time will not meet the expectations of market analysts or investors, which would likely have an adverse effect on the price of our common stock.
Successful Integration of Acquisitions and Management of Growth. The Company's business strategy includes pursuing opportunities to grow the Company's business, both internally and through selective acquisitions, investments, joint ventures and strategic alliances. The Company's ability to implement this strategy depends, in part, on the Company's success in making such acquisitions, investments, joint ventures and strategic alliances on satisfactory terms and successfully integrating them into the Company's operations. Implementation of the Company's growth strategy may impose significant strains on the Company's management, operating systems and financial resources. Failure to manage this growth, or unexpected difficulties encountered during expansion, could have an adverse effect on the Company's business, operating results and financial condition.
Reliance on Strategic Relationship with Systems Integrators. We have established strategic relationships with a number of organizations that we believe are important to our sales, marketing and support activities and the implementation of our products. We believe that our relationships with these organizations provide marketing and sales opportunities for our direct sales force and expand the distribution of our products. These relationships allow us to keep pace with the technological and marketing developments of major software vendors and provide us with technical assistance for our product development efforts.
In particular, we have established a non-exclusive strategic relationship with Andersen Consulting, one of our principal stockholders. We have also entered into significant relationships with other third- party systems integrators such as PricewaterhouseCoopers and Deloitte & Touche Consulting. A significant portion of our revenues have historically been derived from customers for whom Andersen Consulting, or another systems integrator with which we have a significant relationship, have been engaged to provide system integration services. Any deterioration of our relationship with these significant third-party systems integrators could have a material adverse effect on our business, financial condition and results of operations. We also have relationships with Compaq Computer Corporation, IBM Corporation, Microsoft Corporation and Sun Microsystems, among others. Our failure to maintain existing relationships, or to establish new relationships in the future, could have a material adverse effect on our business, results of operations and financial condition.
Our current and potential customers may also rely on third-party system integrators to develop, deploy or manage Siebel Front Office Applications. If we do not adequately train a sufficient number of system integrators, or if these integrators do not have or devote the resources necessary to implement our products, our business, operating results and financial condition could be materially and adversely affected.
The Internet Presents Unique Risks. The Siebel Front Office Applications communicate through public and private networks over the Internet. The success of our products may depend, in part, on our ability to continue developing products which are compatible with the Internet. We cannot predict with any assurance whether the Internet will be a viable commercial marketplace or whether the demand for Internet-related products and services will increase or decrease in the future. The increased commercial use of the Internet could require substantial modification and customization of our products and the introduction of new products. We may not be able to effectively compete in the Internet- related products and services market.
Critical issues concerning the commercial use of the Internet, including security, demand, reliability, cost, ease of use, accessibility, quality of service and potential tax or other government regulation, remain unresolved and may affect the use of the Internet as a medium to support the functionality of our products and distribution of our software. If these critical issues are not favorably resolved, our business, operating results and financial condition could be materially and adversely affected.
A Competitive and Rapidly Changing Market. The market for Web-based application software is relatively new, highly competitive and rapidly changing. We market our products only to customers who have migrated or are in the process of migrating their enterprise computing systems to Web-based computing environments. Our future financial performance will partly depend on the continued growth of organizations successfully adopting Web-based computing environments. If the Web-based applications market fails to grow or grows more slowly than we currently anticipate, our business, operating results and financial condition could be materially and adversely affected.
Customers may not Successfully Implement our Products. Many of our customers purchase and implement our products in phases. Our customers frequently deploy our products to large numbers of sales, marketing and customer service personnel. These end-users may not accept our products. Our products are also being deployed on a variety of computer hardware platforms and used with a number of third-party software applications and programming tools. This use may present significant technical challenges, particularly as large numbers of personnel attempt to use our product concurrently. If existing customers have difficulty further deploying Siebel Front Office Applications or for any other reason are not satisfied with Siebel Front Office Applications, our business, operating results and financial condition could be materially and adversely affected.
A Limited Number of Products for our License Revenues. In 1998 and the first nine months of 1999, a substantial majority of our revenues were attributable to sales of Siebel Front Office Applications. We expect that such product family and related consulting, maintenance and training services will continue to account for a majority of our future revenues. As a result, factors adversely affecting the pricing of or demand for such products, such as competition or technological change, could have a material adverse effect on our business, operating results and financial condition.
The Length of Time Required to Engage a Client and to Implement Our Products may be Lengthy and Unpredictable. The timing of the sales and implementation of our products and services is lengthy and not predictable with any degree of accuracy. You should not rely on prior sales and implementation cycles as any indication of future cycles.
The license of our software products is often an enterprise-wide decision by prospective customers and generally requires us to provide a significant level of education to prospective customers regarding the use and benefits of our products. In addition, the implementation of our products involves a significant commitment of resources by prospective customers and is commonly associated with substantial reengineering efforts that may be performed by the customer or third-party system integrators. The cost to the customer of our product is typically only a portion of the related hardware, software, development, training and integration costs of implementing a large-scale front office software system. For these and other reasons, the period between initial contact and the implementation of our products is often lengthy and is subject to a number of factors which may cause significant delays, over many of which we have little or no control. These factors include (i) the size and complexity of the overall project and (ii) delays in our customers' implementation of Web-based computing environments. A delay in the sale or implementation of even a limited number of license transactions could have a material adverse effect on our business and operations and cause our operating results to vary significantly from quarter to quarter.
Success Requires us to Continue to Expand our Direct Sales Force and Technical Support Staff. We have expanded the distribution of our products in recent years. This expansion has placed new and increased demands on our direct sales force and technical and sales support staff. Our ability to achieve revenue growth in the future will depend, in part, on our success in recruiting and training sufficient direct sales, technical and customer support personnel. Although we invest significant resources to expand our direct sales force and our technical and customer support staff, there is only a limited number of qualified personnel in these areas. Therefore, we may not be able to expand our direct sales force and technical support staff as necessary to support our growing operations. In addition, such expansion may not result in increased revenues. Any failure to expand our direct sales force or technical and customer support staff or to expand our distribution channels could materially and adversely affect our business, operating results and financial condition.
Expanding Distribution May Create Additional Risks. We have recently entered into a number of relationships with resellers in order to obtain broad market coverage. We have generally avoided exclusive relationships with resellers of our products. Discount policies and reseller licensing programs are intended to support each distribution channel with a minimum level of channel conflicts. Any failure to minimize channel conflicts could materially and adversely affect our business, operating results and financial condition.
Revenue is Concentrated in a Relatively Small Number of Customers. Our success depends on maintaining relationships with our existing customers. A relatively small number of customers have accounted for a significant percentage of our revenues. For 1998 and the nine months ended September 30, 1999, license revenues from our ten largest customers accounted for 22% and 15% of total revenues, respectively. We expect that licenses of our products to a limited number of customers will continue to account for a significant percentage of revenue for the foreseeable future. The loss of a small number of customers or any reduction or delay in orders by any such customer, or failure to successfully market our products to new customers could have a material adverse effect on our business, financial condition and results of operations.
Success Requires us to keep Pace with Technological Developments, Evolving Industry Standards and Changing Customer Needs. The software market in which we compete is characterized by (i) rapid technological change, (ii) frequent introductions of new products, (iii) changing customer needs, and (iv) evolving industry standards. To keep pace with technological developments, evolving industry standards and changing customer needs, we must support existing products and develop new products. We may not be successful in developing, marketing and releasing new products or new versions of the Siebel Front Office Applications that respond to technological developments, evolving industry standards or changing customer requirements. We may also experience difficulties that could delay or prevent the successful development, introduction and sale of these enhancements. In addition, these enhancements may not adequately meet the requirements of the marketplace and may not achieve any significant degree of market acceptance. If release dates of any future products or enhancements to the Siebel Front Office Applications are delayed, or if these products or enhancements fail to achieve market acceptance when released, our business, operating results and financial condition could be materially and adversely affected. In addition, new products or enhancements by our competitors may cause customers to defer or forgo purchases of our products, which could have a material adverse effect on our business, financial condition and results of operations.
Success Requires us to Effectively Compete in the Front Office Systems Market. Our products target the front office systems market. This market is highly competitive, rapidly changing and significantly affected by new product introductions. We face competition primarily from our customers' internal information technology departments and systems integrators, as well as from other application software providers that offer a variety of products and services to address this market. Many of our customers and potential customers have attempted to develop front office systems, in- house either alone or with the help of systems integrators. We may not be able to compete successfully against such internal development efforts.
We rely on a number of systems consulting and systems integration firms for a substantial portion of implementation and other customer support services, as well as for recommendations of our products during the evaluation stage of the purchase process. Although we seek to maintain close relationships with these service providers, many of them have similar, and often more established, relationships with our competitors. If we are unable to develop and retain effective, long-term relationships with these third parties, our competitive position could be materially and adversely affected. Further, many of these third parties have significantly greater resources than we do and may market software products that compete with us.
A large number of personal, departmental, enterprise-wide and other products exist in the front office software market. Companies (Products) such as Symantec (ACT!), Saratoga Systems (Avenue), Baan (BaanFrontOffice), Brightware (Brightware Contact Center, Brightware Answer Agent, Brightware Advice Agent), Clarify Inc. - pending purchase by Nortel Networks (ClearSales, ClearSupport), Onyx (Customer Center), Epiphany (e.4 System), Silknet (eBusiness System), IMA (EDGE), Rubric (EMA), Applix (Enterprise), Dendrite International, Inc. (Force One), Firstwave Technologies, Inc. (Netgain), MarketFirst (MarketFirst), Broadvision, Inc. (One-To-One Application System), Oracle Corporation (Oracle Field Sales Online, Oracle Service and Oracle Call, Front Office Application), Open Market (Transact, Folio, ShopSite, Live Commerce), Relavis (OverQuota), Pivotal Software, Inc. (Relationship), SAP AG (Sales Force Automation Solution), SalesLogix (SalesLogix), Portera (ServicePort), MEI (UniverSell), Exchange Applications (ValEX) and The Vantive Corporation - pending purchase by Peoplesoft (Vantive Enterprise) are among the many firms in this market segment.
Some of these competitors have longer operating histories, significantly greater financial, technical, marketing and other resources, significantly greater name recognition and a larger installed base of customers than we do. In addition, many competitors have well- established relationships with our current and potential customers. As a result, these competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, promotion and sale of their products than we can.
There are many factors that may increase competition in the front office systems market, including (i) entry of new competitors, (ii) alliances among existing competitors (iii) consolidation in the software industry and (iv) technological changes or changes in the use of the Internet. Increased competition may result in price reductions, reduced gross margins or loss of market share, any of which could materially adversely affect our business, operating results and financial condition. If we cannot compete successfully against current and future competitors or overcome competitive pressures, our business, operating results and financial condition may be adversely affected.
If we do not Maintain our Relationship with Third-Party Vendors, Interruptions in the Supply of Our Products may result. Portions of our products incorporate software that was developed and is maintained by third-party software developers. Although we believe there are other sources for these products, any significant interruption in the supply of these products could adversely impact our sales unless and until we can secure another source. We depend in part on these third parties' abilities to enhance their current products, to develop new products on a timely and cost-effective basis and to respond to emerging industry standards and other technological changes. We may not be able to replace the functionality provided by the third-party software currently offered with our products if that software becomes obsolete or incompatible with future versions of our products or is not adequately maintained or updated. The absence of or any significant delay in the replacement of that functionality could materially adversely affect our sales.
Software Errors or Defects Could reduce Revenues. Software products frequently contain errors or failures, especially when first introduced or when new versions are released. Although we conduct extensive product testing during product development, we have been forced to delay the commercial release of products until the correction of software problems. We could lose revenues as a result of software errors or defects. Our products are intended for use in sales applications that may be critical to a customer's business. As a result, we expect that our customers and potential customers will have a greater sensitivity to product defects than the market for software products generally. Testing errors may also be found in new products or releases after commencement of commercial shipments, resulting in loss of revenue or delay in market acceptance, damage to our reputation, or increased service and warranty costs, any of which could have a material adverse effect upon our business, operating results and financial condition.
If we do not Successfully Manage Our Growth, our Business may be Negatively Impacted. Our business has grown rapidly in recent years. This growth has placed a significant strain on our management systems and resources. To manage future growth we must continue to (i) improve our financial and management controls, reporting systems and procedures on a timely basis and (ii) expand, train and manage our employee work force. If we fail to manage our growth effectively, our business, financial condition and results of operations could be materially and adversely affected.
The Loss of our Key Personnel Could Negatively Affect our Performance. Our performance depends on the continued service of our key technical, sales and senior management personnel, particularly Thomas M. Siebel, our Chairman and Chief Executive Officer. None our key employees has entered into an employment agreement with us. The loss of the services of one or more of our executive officers could have a material adverse effect on our business, operating results and financial condition.
The Protection of Our Proprietary Information is Limited. We rely primarily on a combination of patent, copyright, trade secret and trademark laws, confidentiality procedures and contractual provisions to protect our proprietary rights. We also believe that the technological and creative skills of our personnel, new product developments, frequent product enhancements, name recognition and reliable product maintenance are essential to establishing and maintaining a technology leadership position. We seek to protect our software, documentation and other written materials under patent, trade secret and copyright laws, which afford only limited protection. Any patents issued to us may be invalidated, circumvented or challenged. Any of our pending or future patent applications, whether or not being currently challenged, may not be issued with the scope of the claims we seek, if at all. Furthermore, others may develop technologies that are similar or superior to our technology or design around our patents. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the United States. Our means of protecting our proprietary rights in the United States or abroad may not be adequate. We have entered into agreements with substantially all of our customers that require us to place Siebel Front Office Applications source code into escrow. Such agreements generally provide that such parties will have a limited, non-exclusive right to use such code if (i) there is a bankruptcy proceeding by or against us, (ii) we cease to do business, or (iii) we fail to meet our support obligations.
Although we do not believe that we are infringing any proprietary rights of others, third parties may claim that we have infringed their intellectual property rights. Furthermore, former employers of our former, current or future employees may assert claims that such employees have improperly disclosed to us the confidential or proprietary information of such former employers. Any such claims, with or without merit, could (i) be time consuming to defend, (ii) result in costly litigation, (iii) divert management's attention and resources, (iv) cause product shipment delays, and (v) require us to pay money damages or enter into royalty or licensing agreements. A successful claim of product infringement against us and our failure or inability to license or create a workaround for such infringed or similar technology may materially and adversely affect our business, operating results and financial condition.
We license certain software from third parties. These third-party software licenses may not continue to be available to us on acceptable terms. The loss of, or inability to maintain, any of these software licenses could result in shipment delays or reductions. This could materially adversely affect our business, operating results and financial condition.
Year 2000 Problems may cause an Interruption in our Business. Many existing computer programs and systems use only two-digit fields to identify the year, e.g. 85=1985, and they are unable to process date and time information between the twentieth and twenty-first centuries. Accordingly, computer programs and software may need to be modified prior to the year 2000 in order to remain functional. Although the Company has spent a large amount of time and resource to address potential Y2K problems, there is no assurance that the Company will be successful in its efforts to identify and address all Y2K issues. Failure to complete the necessary modifications could cause a disruption or failure of such program and system. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Year 2000 Preparedness."
International Operations involve Unique Risks. Our revenues are primarily derived from large multi-national companies. To service the needs of these companies, we must provide worldwide product support services. We have expanded, and intend to continue expanding, our international operations and enter additional international markets. This will require significant management attention and financial resources that could adversely affect our operating margins and earnings. We may not be able to maintain or increase international market demand for Siebel Front Office Applications. If we do not, our international sales will be limited, and our business, operating results and financial condition could be materially and adversely affected.
Our international operations are subject to a variety of risks, including (i) foreign currency fluctuations, (ii) economic or political instability, (iii) shipping delays and (iv) various trade restrictions. Any of these risks could have a significant impact on our ability to deliver products on a competitive and timely basis. Significant increases in the level of customs duties, export quotas or other trade restrictions could also have an adverse effect on our business, financial condition and results of operations. In situations where direct sales are denominated in foreign currency, any fluctuation in foreign currency or the exchange rate may adversely affect our business, financial condition and results of operations. The Company generally manages its foreign currency exchange rate risk by entering into contracts to sell foreign currency at the time a foreign currency receivable is generated. When the foreign currency receivable is collected, the contract is liquidated, thereby converting the foreign currency to US dollars and mitigating the exchange rate risk. In certain instances, the Company has not hedged foreign currency receivables when the forward contracts in the relevant currency were not readily available or were not cost effective.
Certain Stockholders may be able to Exercise Control over Matters Requiring Stockholders Approval. Our current officers, directors and entities affiliated with us together beneficially owned a significant portion of the outstanding shares of common stock as of September 30, 1999. While these stockholders do not hold a majority of the Company's outstanding common stock, they will be able to exercise significant influence over matters requiring stockholder approval, including the election of directors and the approval of mergers, consolidations and sales of our assets. This may prevent or discourage tender offers for our common stock.
Stock Price may Continue to be Volatile. Our stock price has fluctuated substantially since our initial public offering in June 1996. The trading price of our common stock is subject to significant fluctuations in response to variations in quarterly operating results, the gain or loss of significant orders, changes in earning estimates by analysts, announcements of technological innovations or new products by us or our competitors, general conditions in the software and computer industries and other events or factors. In addition, the stock market in general has experienced extreme price and volume fluctuations which have affected the market price for many companies in industries similar or related to ours and which have been unrelated to the operating performance of these companies. These market fluctuations have, at times, adversely affected and may continue to adversely affect the market price of our common stock.
Certain Provisions in our Charter Documents may Prevent certain Corporate Actions. Our Board of Directors is authorized to issue up to 2,000,000 shares of Preferred Stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further approval by our stockholders. The Preferred Stock could be issued with voting, liquidation, dividend and other rights superior to those of the common stock. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The issuance of Preferred Stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could make it more difficult for a third party to acquire a majority of our outstanding voting stock. We have instituted a classified Board of Directors in our Certificate of Incorporation. This and certain other provisions of our Certificate of Incorporation and certain provisions of our Bylaws and of Delaware law, could delay or make more difficult a merger, tender offer or proxy contest.
Substantial Leverage and Debt Service Obligations. The Company has substantial amounts of outstanding indebtedness, primarily in the form of subordinated notes. As a result of this indebtedness, the Company's principal and interest payment obligations have increased substantially. There is the possibility that the Company may be unable to generate cash sufficient to pay the principal of, interest on and other amounts due in respect of the Company's indebtedness when due. The Company also expects to add additional equipment loans and lease lines to finance capital expenditures and may obtain additional long-term debt, working capital lines of credit and lease lines. There can be no assurance that any financing arrangements will be available.
The Company's substantial leverage could have significant negative consequences, including:
o increasing vulnerability to general adverse economic and industry conditions;
o limiting the Company's ability to obtain additional financing;
o requiring the dedication of a substantial portion of the Company's expected cash flow from operations to service the Company's indebtedness, thereby reducing the amount of the Company's expected cash flow available for other purposes, including capital expenditures;
o limiting the Company's flexibility in planning for, or reacting to, changes in the Company's business and the industry in which the Company competes;
o placing the Company at a possible competitive disadvantage vis- a-vis less leveraged competitors and competitors that have better access to capital resources.
Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Many of the statements made by or about the Company in this Form 10-Q are forward-looking statements. These forward-looking statements include, but are not limited to, statements about the Company's industry, plans, objectives, expectations, intentions, assumptions, and other statements that are not historical facts. When used in this Form 10-Q, the words "expect," "anticipate," "intend," "plan," "believe," "seek," "estimate," and similar expressions are generally intended to identify forward-looking statements. Because these forward-looking statements involve risks and uncertainties, including those described in this "Factors Affecting Operating Results" section, actual results may differ materially from those expressed or implied by these forward-looking statements. Market data and other market and industry information presented in this Form 10-Q have been obtained from independent industry sources. Although the Company believes these sources are reliable, the Company has not independently verified any of such data or information.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The tables below provide information about the Company's derivative financial instruments and financial instruments that are subject to market risk. These include foreign currency forward contracts used to hedge foreign currency receivables and intercompany balances, which are subject to exchange rate risk, and available-for-sale short-term investments, which are subject to interest rate risk. The Company does not consider its cash equivalents to be subject to interest rate risk due to their short maturities.
The Company generally manages its foreign currency exchange rate risk by entering into contracts to sell foreign currency at the time a foreign currency receivable is generated. When the foreign currency receivable is collected, the contract is liquidated, thereby converting the foreign currency to US dollars and mitigating the exchange rate risk.
The Company manages its interest rate risk by maintaining an investment portfolio with debt instruments of high credit quality and relatively short average maturities. The Company also manages interest rate risk by maintaining sufficient cash and cash equivalent balances such that it is typically able to hold its investments to maturity.
The Company is exposed to equity price risks on its marketable equity securities. This investment is in a publicly-traded company in the high- technology industry sector. The Company typically does not attempt to reduce or eliminate its market exposure on these securities. A 10% adverse change in the equity price would result in an approximate $4.7 million decrease in the fair value of the Company's marketable equity securities as of September 30, 1999.
The following summarizes the Company's foreign currency forward contracts, all of which mature in 1999, by currency, as of September 30, 1999. Contract amounts are representative of the expected payments to be made under these instruments (unaudited, in thousands):
Fair
Contract Contract Value at
Amount Amount September 30,
(Pay) (Receive) 1999
---------------- --------- ---------
German marks (contracts to pay
DM/receive US$)................. DM 4,930 US$2,664 US$(20)
British pounds (contracts to pay
(Pounds)/receive US$)............ (Pounds) 4,741 US$7,628 US$(179)
Japanese yen (contracts to pay
(Yen)/receive US$)............... (Yen) 1,543,100 US$13,795 US$(714)
Euro (contracts to pay
EUR/receive US$)................ EUR 2,300 US$2,475 US$26
Bristish pounds (contracts to pay
(Pounds)/receive EUR)............ (Pounds) 830 EUR 1,279 US$ 5
The following summarizes the Company's short-term investments and the
weighted average yields, as of September 30, 1999 (unaudited, in
thousands):
Expected maturity date
-----------------------------------------------------
There-
1999 2000 2001 2002 2003 after
-------- -------- -------- -------- -------- --------
US treasury securities.. -- -- $1,986 $3,002 $1,984 $3,900
Wtd. Avg. Yld........... 5.88% 5.71% 5.73% 6.84%
Municipal securities.... $8,701 $55,234 $37,226 $36,708 $5,347 --
Wtd. Avg. Yld........... 3.86% 3.85% 3.78% 4.29% 4.39%
Corporate bonds......... -- -- -- $4,505 -- --
Wtd. Avg. Yld........... 5.93%
On September 30, 1999, the Company had an investment portfolio of fixed income securities, excluding those classified as cash and cash equivalents, of $158,600,000. These securities, like all fixed income instruments, are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 100 basis points from levels as of September 30, 1999, the fair value of the portfolio would decline by approximately $2,400,000.
Part II - Other Information
Item 1. Legal Proceedings
In June 1996, Debra Christoffers, a former sales person of the Company, filed a complaint for wrongful termination against the Company and Thomas Siebel, in the Superior Court of California, County of San Mateo. On May 15, 1998, a jury returned verdicts in favor of Mr. Siebel and against the Company for an immaterial amount. Both the plaintiff and the Company have filed notices of appeal. The matter has since been settled on terms that the Company considers favorable.
In October 1999, SAP America, Inc. filed a complaint against the Company in the Court of Common Pleas of Delaware County, Pennsylvania. The Complaint alleges tortuous interference with contractual relations, predatory hiring, misappropriation of trade secrets, and unfair competition in connection with the Company's employment of 27 individuals formerly employed by SAP America or its affiliated companies. The Company believes the claims are without merit, and intends to defend itself vigorously. The Company believes that the ultimate outcome of the action will not have a material effect on the Company's financial position or results of operations, although there can be no assurance as to the outcome of such litigation.
The Company is engaged in other legal actions arising in the ordinary course of business. The Company believes it has adequate legal defenses and believes that the ultimate outcome of these actions will not have a material effect on the Company's financial position or results of operations.
Item 2. Changes in Securities and Use of Proceeds
The effective date of the Company's first registration statement, filed on Form S-1 under the Securities Act of 1933 (No. 333-12061) relating to the Company's initial public offering of its Common Stock, was June 27, 1996. There has been no change to the disclosure contained in the Company's report on Form 10-Q for the quarter ended March 31, 1998 regarding the use of proceeds generated by the Company's initial public offering of its Common Stock.
Item 4. Submission of Matters to a Vote of Security Holders
A Special Meeting of Stockholders was held on October 20, 1999 to act on the following matters:
1. To approve an amendment to the Company's Certificate of Incorporation to increase the authorized number of shares of Common Stock from 300,000,000 shares to 800,000,000 shares. The votes cast for and against this amendment were 76,786,323 and 4,939,828 respectively, with 89,127 shares abstaining.
2. To approve an amendment to the Company's 1996 Equity Incentive Plan to increase the aggregate number of shares of Common Stock authorized for issuance under such plan by 15,000,000 shares, from 40,000,000 shares to 55,000,000 shares. The votes cast for and against this amendment were 40,740,919 and 24,744,860, respectively, with 183,839 shares abstaining.
Based on these voting results, the amendment to the Company's Certificate of Incorporation, as amended, to increase the authorized number of shares of Common Stock from 300,000,000 shares to 800,000,000 shares and the amendment to the Company's 1996 Equity Incentive Plan to increase the aggregate number of shares of Common Stock authorized for issuance under such plan by 15,000,000 shares, from 40,000,000 shares to 55,000,000 shares, was approved.
Item 6: Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit Number Description of Document
-------------- -----------------------
2.1 Agreement and Plan of Merger and Reorganization, dated March 1,1998,
among the Registrant, Syracuse Acquisition Sub, Inc. and Scopus
Technology, Inc.(4)
3.1 Amended and Restated Certificate of Incorporation of the Registrant, as
amended.(6)
3.2 Bylaws of the Registrant.(1)
4.1 Reference is made to Exhibits 3.1 and 3.2.
4.2 Specimen Stock Certificate.(1)
4.3 Restated Investor Rights Agreement, dated December 1, 1995, between the
Registrant and certain investors, as amended April 30, 1996 and June 14,
1996.(1)
10.1 Registrant's 1996 Equity Incentive Plan, as amended.(3)
10.2 Registrant's Employee Stock Purchase Plan, as amended.(3)
10.3 Form of Indemnity Agreement entered into between the Registrant and
its officers and directors.(1)
10.4 Registrant's Deferred Compensation Plan, dated January 10,1997.(5)
10.5 Master Alliance Agreement, dated March 17, 1995, between the Registrant
and Andersen Consulting LLP.(1)(2)
10.6 Assignment Agreement, dated September 20, 1995, by and between the
Registrant and Thomas M. Siebel.(1)
10.7 Lease Agreement, dated June 4, 1996, by and between the Registrant and
Crossroad Associates and Clocktower Associates.(1)
27.1 Financial Data Schedule.(7)
_____________________
(1) Incorporated by reference to the Registrant's Registration Statement on Form
S-1 (No. 333-03751), as amended.
(2) Confidential treatment has been granted with respect to portions of this
exhibit.
(3) Incorporated by reference to the Registrant's Registration Statement on Form
S-8 (No. 333-07983), as amended.
(4) Incorporated by reference to exhibit 99.1 of the Registrant's Current Report
on Form 8-K filed by the Registrant on March 16, 1998.
(5) Incorporated by reference to the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1996.
(6) Incorporated by reference to the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1997.
(7) Filed herewith.
(b) Reports on Form 8-K
None
SIEBEL SYSTEMS, INC.
SIGNATURES
Pursuant to the requirement of the Security Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| SIEBEL SYSTEMS, INC. |
| (Registrant) |
Dated: November 15, 1999
| By: | /s/ Howard H. Graham |
|
| |
| Howard H. Graham | |
|
Senior Vice President Finance and Administration and Chief Financial Officer | |
| (Principal Financial Officer) |
| By: | /s/ Paul J. Gifford |
|
| |
| Paul J. Gifford | |
| Vice President, Controller | |
| (Principal Accounting Officer) |
|
|