Investing: The Software Field Guide

(1)

Industry Note January 20, 2004 C. Eugene Munster

Senior Research Analyst Security & Design

612-303-6452, [email protected] Tad W. Piper, CFA

Senior Research Analyst Software Applications

650-838-1393, [email protected] David M. Rudow

Senior Research Analyst Technology Software

Reason for Report: Industry Overview This report should be read in conjunction with important disclosure information found at the following site:

http://www.piperjaffray.com/disclosures

The Software Field Guide

Volume 3, Number 1

Subscribe at www.gotoanalysts.com/softwaresubscribe

Did you knowthat while experimenting with ways to make rubber stronger, Charles Goodyear accidentally dropped a mixture of rubber and sulphur on a hot stove? The accident led to the development of the process of

vulcanization, which made the invention of tires and the automobile possible. Did you also know that The Software Field Guide is the best weekly source for information on the world of software?

IBM’s Q4 Results: Implications for Infrastructure

Software

IBM recently reported strong results for the December quarter of 2003, posting total revenue of $25.91 billion and EPS of $1.56, ahead of consensus expectations of $25.06 billion and $1.50, respectively. On the Company’s earnings call, management sounded upbeat, stating that customers were starting to buy again, and they expect 2004 to mark the beginning of the next IT spending growth cycle.

IBM’s software business also performed well in the quarter, with total revenue of $4.25 billion, up 23% q/q and 12% y/y (or up an estimated 6% y/y excluding the impact of the Rational acquisition). On the call, IBM highlighted software areas that performed particularly well or poorly in the quarter. We believe these results can provide some insight into what other companies may have benefited or suffered as a result of the same trends. WebSphere grew 10% y/y in the quarter, versus 12% y/y growth in Q3 and 14% y/y growth in both Q2 and Q1. The downtick in y/y growth is not surprising, since Q4 was the slowest growing quarter on a y/y basis for the two previous years as well. WebSphere encompasses a broad area of software products, including integration, application servers, and portals. Management highlighted portal as an especially fast-growing segment of the WebSphere suite, growing 42% y/y. We believe the demand for portal software may benefit other vendors as well. Specifically, companies such as BEA, Vignette, and Plumtree (#) all have strong portal offerings that may be seeing similar strength.

Piper Jaffray & Co. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decisions. This report should be read in conjunction with important disclosure information, including an attestation under Regulation Analyst Certification, found at the end this report or at the following site: http://www.piperjaffray.com/researchdisclosures.

(2)

Industry Note January 20, 2004

Data Management software grew 5% in the quarter. Within that, DB2 grew 3%, enterprise content management grew only 2%, and database management tools grew 20%. The strong growth in database management tools may indicate that database administrators are looking to manage their existing databases more efficiently, and may bode well for other database tools vendors, specifically Embarcadero and Quest Software, and (to a lesser extent) BMC Software.

We found the slow 2% growth in enterprise content management somewhat disappointing, since IBM has made a few acquisitions in this area in recent months that we would have expected to drive stronger growth. Another ECM vendor, Stellent, also preannounced soft results for the December quarter. We believe the disappointing results are in part due to a softer overall demand environment for content management in Q4, but may also be indicative of increased competitive pressure from a reinvigorated Interwoven following the completion of the iManage acquisition in November.

Tivoli posted strong growth in the quarter, up 17% y/y. Within that, Tivoli Storage posted exceptional growth, up 32% y/y. This performance is a good indication for strong results from other storage software companies as well, namely Veritas and EMC/Legato (#). Tivoli Systems grew 14% in the quarter. However, getting a direct impact from this figure is somewhat challenging since the Systems suite encompasses a broad variety of products including both mainframe and distributed systems management as well as application performance management.

MIPS shipments were robust in the quarter, up 60% y/y. We believe that the increase is primarily a function of an increased number of Linux deployments on the mainframe, but this increase could also benefit systems management software vendors that price their software on a MIPS-based model. Companies with MIPS-based pricing on the mainframe include BMC Software and CA.

Overall, we believe that IBM’s solid results point to an improving IT spending environment. While only time will tell if 2004 truly marks the beginning of the next IT growth cycle, IBM’s optimism is a good indication that times may finally be getting a little better.

INDUSTRY NEWS

· Siebel: The head of worldwide sales at Siebel, Richard Chiarello, is leaving the company after 15 months on the job. He was the third head of sales for the Company in two years. When the Company preannounced its earnings on September 5, 2004, management announced the promotion of three regional vice presidents who would report to Chiarello as part of an internal realignment. On Chiarello's departure, management commented that his position is simply being eliminated as part of the reorganization, and that the three regional vice presidents will now report directly to Tom Siebel.

· Oracle: Billionaire Larry Ellison (59) tied the knot with longtime sweetheart and romance novelist, Melanie Craft (35) in December. On Monday, January 12, management changes were announced at Oracle. Ellison is stepping down as chairman but will remain the CEO. Jeff Henley will become the chairman of the board and will step down as CFO as soon as a replacement is found. The long open position of president will be filled by two people, Safra Catz, currently head of operations and a member of the board, and Charles Phillips, who will become a member of the board, retain his duties as head of marketing, and take over as head of field operations, sales, and consulting.

· PeopleSoft announced that it has extended its customer assurance program, the insurance program that protects customers' investment in PeopleSoft products should the Company be acquired by Oracle. PeopleSoft has indicated that it will continue to extend the program until the takeover threat goes away.

(3)

benefits include improved quality of data, reduced item master errors, faster time-to-market for new product introductions, and reduced labor costs.

· QAD, a mid-market ERP software vendor, and a leading provider of solutions for the global manufacturing companies, announced the expansion of its South Korean operations. QAD already has more than 60 customers in South Korea, and is active in 80 countries worldwide. QAD Korea Ltd. will be a regional reseller and partner to manufacturing customers in Korea.

Companies mentioned in The Software Field Guide that are covered by Piper Jaffray & Co.: BEA Systems, Inc. (BEAS, $14.20, OP, #)

BMC Software, Inc. (BMC, $20.86, MP, #)

Computer Associates International, Inc. (CA, $28.46, OP, #) Embarcadero Technologies, Inc. (EMBT, $15.41, OP, #) FreeMarkets, Inc. (FMKT, $8.54, MP, #)

Interwoven, Inc. (IWOV, $14.75, OP, #) Oracle Corporation (ORCL, $14.85, OP, #) PeopleSoft, Inc. (PSFT, $22.86, OP, #) Quest Software, Inc. (QSFT, $16.56, MP, #) Retek, Inc. (RETK, $11.30, MP, #)

Siebel Systems, Inc. (SEBL, $15.13, MP, #) Stellent, Inc. (STEL, $9.30, MP, #+)

VERITAS Software Corporation (VRTS, $40.09, OP, #) Vignette Corporation (VIGN, $2.85, OP, #)

Ratings (see last page for details): (OP) Outperform

(MP) Market Perform (UP) Underperform

Disclosures (see last page for details): (#) Market Maker

(~) Employee/Director

(<) Investment Banking Services – 3 month look forward (^) Analyst Financial Interest

(>) Investment Banking Services – 12-month look back (@) Underwriter

(+) One Percent (*) Pre-IPO Investment

(4)

Important Research Disclosures

Analyst Certification—Gene Munster, Tad Piper, and David Rudow

The views expressed in this report, including the Key Points and Risk sections in particular, accurately reflect my personal views about the subject Company and the subject security. In addition, no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report.

Research Disclosures

The following disclosures apply to securities mentioned in this report if and as indicated: (#) Piper Jaffray was making a market in the Company’s securities at the time this research report was published. Piper Jaffray will buy and sell the Company’s securities on a principal basis. (^) A Piper Jaffray analyst who follows this Company or a member of the analyst’s household has a financial interest (a long equity position) in the Company’s securities. (@) Within the past 12 months Piper Jaffray was a managing underwriter of an offering of, or a dealer manager of a tender offer for, the Company’s securities or the securities of an affiliate. (>) Piper Jaffray has received compensation for investment banking services from the Company within the past 12 months. (<) Piper Jaffray expects to receive or intends to seek compensation for investment banking services from the Company in the next 3 months. (~) A Piper Jaffray officer, director, or employee (other than a research analyst who follows the Company) is an officer and/or director of the Company. (+) Piper Jaffray and its affiliates, in aggregate, beneficially own 1% or more of a class of common equity securities of the Company. (=) Piper Jaffray has received compensation for non-investment banking securities-related services from the Company within the past 12 months. (&) A Piper Jaffray analyst who follows this Company has received compensation from the Company in the last 12 months. (*) Piper Jaffray and/or its employees (other than the analyst who follows this Company) own securities of this Company that were acquired prior to the Company’s IPO.

Rating Definitions

Investment Opinion: Investment opinions are based on each stock’s return potential relative to broader market indices*, not on an absolute return.

· Outperform: Expected to outperform the relevant broader market index over the next 12 months.

· Market Perform: Expected to perform in line with the relevant broader market index over the next 12 months.

· Underperform: Expected to underperform the relevant broader market index over the next 12 months. * Russell 2000 and S&P 500

Risk Rating: Our focus on growth companies implies that the stocks we recommend are typically more volatile than the overall stock market. We are not recommending the “suitability” of a particular stock for an individual investor. Rather, it identifies the volatility of a particular stock.

· Low: The stock price has moved up or down by more than 10% in a month in fewer than 8 of the past 24 months.

· Medium: The stock price has moved up or down by more than 20% in a month in fewer than 8 of the past 24 months.

· High: The stock price has moved up or down by more than 20% in a month in at least 8 of the past 24 months. All IPO stocks automatically get this volatility rating for the first 12 months of trading.

(5)

Disclaimer

Piper Jaffray research analysts receive compensation that is based, in part, on the firm's overall revenues, which include investment banking revenues. Piper Jaffray research analysts who follow this Company report to the Head of Investment Research who, in turn, reports directly to the Chief Executive Officer of Piper Jaffray.

This material is based on data obtained from sources we deem to be reliable; it is not guaranteed as to accuracy and does not purport to be complete. This information is not intended to be used as the primary basis of investment decisions. Because of individual client requirements, it should not be construed as advice designed to meet the particular investment needs of any investor. It is not a representation by us or an offer or the solicitation of an offer to sell or buy any security. Further, a security described in this release may not be eligible for solicitation in the states in which the client resides. Officers or employees of affiliates of Piper Jaffray & Co., or members of their families, may have a beneficial interest in the Company's securities and may purchase or sell such positions in the open market or otherwise. Notice to customers in the United Kingdom:This report is a communication made in the United Kingdom by Piper Jaffray & Co. to market counterparties or intermediate customers and is exclusively directed at such persons; it is not directed at private customers and any investment or services to which the communication may relate will not be available to private customers. In the United Kingdom, no persons other than a market counterparty or an intermediate customer should read or rely on any of the information in this communication.

Securities products and services offered through Piper Jaffray & Co., member SIPC and NYSE, Inc., a subsidiary of Piper Jaffray Companies. Additional information is available upon request.

No part of this report may be reproduced, copied, redistributed or posted without the prior consent of Piper Jaffray & Co. © 2004 Piper Jaffray & Co., 800 Nicollet Mall, Suite 800, Minneapolis, Minnesota 55402-7020