Think of USinternetworking <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: USIX)") else Response.Write("(Nasdaq: USIX)") end if %> as kind of a utility company that sells software on a monthly basis the same way your local power company provides electricity. Technically, it's an application service provider, a company that hosts complex software systems such as human resource and financial management systems for businesses. It's helping change the way companies buy and deploy software.
The company is a first mover in an emerging field that Forrester Research <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: FORR)") else Response.Write("(Nasdaq: FORR)") end if %> thinks could grow from $1 billion in 1997 to $21 billion in 2001. Founded just early last year, the company moved quickly to form partnerships with software companies that include Siebel Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SEBL)") else Response.Write("(Nasdaq: SEBL)") end if %>, PeopleSoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PSFT)") else Response.Write("(Nasdaq: PSFT)") end if %>, BroadVision <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BVSN)") else Response.Write("(Nasdaq: BVSN)") end if %>, Ariba <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ARBA)") else Response.Write("(Nasdaq: ARBA)") end if %>, and Microsoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %>. We spoke with USi founder, Chairman, and CEO Christopher McCleary about the company's industry, emerging opportunities, and profitability.
TMF: Start with the basics. What kind of services do you offer?
McCleary: We've secured partnerships with major enterprise software companies and created a global infrastructure that enables us to provide the use of that software as a continuously supported service to midmarket business.
| "[A]bout one-third of our customers are Fortune 1000 companies. They're divisions, or subsidiaries of these larger companies, such as Hewlett Packard, GE Capital, and US West." |
TMF: So essentially it's one-stop shopping when it comes to an enterprise software product.
McCleary: That's correct. A small distinction is that we really don't provide an enterprise resource planning (ERP) package per se. We have established a best-of-breed philosophy, so we provide PeopleSoft human resources software, but we provide that to a company that has an existing SAP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SAP)") else Response.Write("(NYSE: SAP)") end if %> or Baan <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BAANF)") else Response.Write("(Nasdaq: BAANF)") end if %> core financials package. The difference is ERP has the connotation of several applications bundled up.
One of the other big differences is that we don't charge for professional services for installation or implementation. In fact, it's included in our monthly service quote so there's virtually no investment on behalf of the customer. That's as opposed to time and materials or even fixed-price contracts that were the standard way of doing things.
TMF: All the complexity is handled in your data centers, right? In other words the customer doesn't need to have any kind of an IT staff?
McCleary: That's correct. In fact, when we give a service level agreement -- the acronym is SLA -- we don't just give a service level agreement for the application. We give an SLA for how that application performs in the network environment and it includes all of the elements to make it perform. It's really a breakthrough on the support side.
TMF: So it's a guarantee that the software is going to be able to do what the company expects?
McCleary: Yeah. With no outs. So we can't say, hey the Bell Atlantic <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BEL)") else Response.Write("(NYSE: BEL)") end if %> circuit was down. We provide it so it's part of our challenge to keep that up and operating. That's an integral part of the functionality of the service.
TMF: You said there's almost no up-front cost for some of the agreements. What's it cost?
McCleary: In our third-quarter earnings release, we estimated the average customer was paying us about $33,000 a month and the average contract term was about three-and-a-half years. Normally they would have invested over a million dollars in hardware and software and they're maybe paying $15,000 to $20,000 a month to operate it internally, so this is not only a value proposition, but it runs at better service levels because we professionally manage it 24 hours a day.
TMF: In terms of the size of the market, how rapidly do you think it's going to grow?
McCleary: You know, when we first looked at it we thought this was a middle-market product that would be primarily of interest to the midmarket -- there's about 400,000 midmarket businesses in the U.S. But about one-third of our customers are Fortune 1000 companies. They're divisions, or subsidiaries of these larger companies, such as Hewlett-Packard <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %>, GE Capital, and U.S. West <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: USW)") else Response.Write("(NYSE: USW)") end if %>.
All of these are Fortune 500 companies that have to get their projects launched and running, and they found this a very attractive way to do it, not only in terms of benefits but they didn't have to get additional resources allocated, which is very difficult to do in large companies.
TMF: Is it hard to convince customers to keep their proprietary data on a network controlled by an outsider?
McCleary: Not anymore. People are past that now. There's been several billions invested in security. Some customers have commented that we offer a better place for their data since many technology officials think about 80% of intrusions now are generated internally.
TMF: As far as market size, Forrester thinks the market could go from $1 billion in '97 to $21 billion in 2001. Does that sound reasonable?
McCleary: We're seeing a proliferation of different types of applications at the same customer. We've got three separate contracts with one company because they all found out that they could do these individually on their own budget, in their own timeframe, and could accelerate the deployment.
So we think that numbers like that are not out of the question because this makes it much more palatable, easy for the business line manager to make decisions on their own, and have a good responsible service provider to really partner with them on delivering as much needed automation as possible.
TMF: How many SLAs do you have at this point?
McCleary: At the end of Q3 we can quote we have 81 contracts. Those contracts total over $100 million contract value and every one of our customers has a service level agreement.
TMF: You've built four data centers at this point, right?
McCleary: Correct.
TMF: What's the capacity of your data centers? How much have you invested so far?
McCleary: We don't have to build more data centers. We have two co-primary data centers in North America, one in Asia, one in Europe, and they're all connected. The Asian and European [centers] are more satellite data centers because they are only used to improve the performance. We haven't yet started to market European or Asian customers so any data center built would be outside of the U.S. probably with Europe first, then Asia. Today we've got about $75 million invested in the infrastructure and we've got capacity for about 400 customers -- something like that. And then we don't build new data centers. What we do is incrementally expand the floor space of the existing data centers.
TMF: Will it be a challenge getting people on staff quickly enough to acquire 400 service contracts?
McCleary: It's always a challenge, especially for the good people, but I would say that by this time next year we'll probably have 2000 employees.
TMF: How many employees are you up to now?
McCleary: About 900.
TMF: A lot of people are getting into the ASP market now. What's different about USi?
McCleary: Actually two things. Number one, when we built USi, we put together a lot of case studies. We said OK, if we had a clean sheet -- which we did -- how do we build a business from scratch -- no legacy. We want to be very focused on only one business, and that's providing the best application service in the world.
| "In our third quarter earnings release, we estimated the average customer was paying us about $33,000 a month and the average contract term was about three and a half years." |
Second, since we got involved early we have a first-mover advantage. We're really ahead of the curve on some of the support issues, and also we get the advantage of looking at many opportunities because of this leadership position that others maybe don't get to look at, such as some of the new applications that we've pioneered -- Lawson and Ariba and others.
Lastly we're well capitalized. We've got over $200 million on the balance sheet and we're able to access the capital markets and grow at a rate that's not constrained because we have hit this momentum point of having over $100 million in contract value.
TMF: In terms of the kind of software services that you want to offer your customers, what are the areas you'd like to target?
McCleary: Well, right now we've got the following sectors: We have BroadVision and Microsoft Site Server that are the two platforms in our e-commerce group. In our customer relation management (CRM) we're 100% Siebel, both enterprise and work groups. We also have a link to our homepage to Siebel for individuals. On the core accounting and in human resources, we've got Lawson and PeopleSoft. And then for data warehouse we have Sagent <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SGNT)") else Response.Write("(Nasdaq: SGNT)") end if %>. For corporate messaging and collaboration we've got Microsoft Exchange. And one of the spaces that we felt was going to be unfolding very nicely next year was business-to-business commerce or procurement so we added Ariba last week.
As far as going forward we think storage, network storage, and document management as well as some more niche applications for various vertical markets that we're still exploring right now.
TMF: When will you reach profitability?
McCleary: First Call estimates are mid-2001 for [EBITDA] break even.
TMF: For potential investor looking at this business, what measures should they be looking at to judge its success?
McCleary: I would say the diversity of the customer base and contract attainment. I wouldn't necessarily look at revenue because we don't collect up front, but look at the back log and the contract value. We've got Hewlett-Packard as a customer running their new HPDirect.com site; we've got the Baltimore Sun. We've got Providian <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PVN)") else Response.Write("(NYSE: PVN)") end if %> and All Books for Less. It's a great mix of different types of companies that have selected us to do, usually, one best of breed application. We think that's a great endorsement of our model, that it's so well received by both big and mid-sized companies.
TMF: The bulk of your revenues at this point come from that monthly contract log, right? Isn't that upwards around 70% at the end of the third quarter?
McCleary: Yeah. It'll be 90% by the time we have EBITDA break even. There's still some project revenue, but most of our revenue now is layering on these multi-year recurring revenue contracts.
TMF: There were expense issues that had people concerned in the second quarter and you did some things in the third quarter to rein things in. Can you talk a little bit about what was happening and what you were able to do?
McCleary: Well, we really geared up and we were geared up way ahead of time. Although our revenue was about 25% ahead of FirstCall, all of our learning curve and support mechanisms were geared up for even a higher lever of achievement. So once we landed all the big contracts in Q3 all of our overhead and fixed costs became more fully absorbed. That was really it.
TMF: Going forward, what would you say is the biggest challenge facing the company?
McCleary: When we submit a proposal to a prospect generally one of the comments that comes back is they can't believe it. They can't believe that one provider is taking on all of this varied responsibility. So education is probably our biggest challenge.
Secondly would be to get the Fool.com over here. Upgrade your level of service.
TMF: To what extent will the companies that run their own applications start outsourcing in the coming years?
McCleary: Most of our contract attainment comes from new applications. So it's somebody that wants a PeopleSoft human resources module because it's the best of breed, or it's somebody that has maybe a Great Plains <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GPSI)") else Response.Write("(Nasdaq: GPSI)") end if %> application and wants to upgrade to Lawson. Lawson is a 100% Web-enabled, core accounting system. I think we've done maybe one where they've actually had deployed and they turned it over to us.
TMF: Thanks very much for your time.
McCleary: Great. Thanks a lot.
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