Bottom of the Barrel: A Witness (Systems) to Growth

Witness this: A company with no earnings, a market cap of less than $200 million and average daily volume of just over 50,000 shares. Sounds dicey.

It is. But, Witness Systems (WITS) -- a software company committed to quality -- also has a barrelful of potential. Hence, we take a deeper look at this small-cap in this installment of Bottom of the Barrel.

Witness to Quality

Witness Systems is a Roswell, Ga.-based, software development and services firm focused on customer service. Witness develops products that help companies monitor call center activity -- customer service, technical support and billing centers -- to improve efficiency and quality in sensitive customer contact situations.

At a Glance Witness Systems (WITS:Nasdaq)
Current Price	$8.00
52-Week Range	$5.62 - 18.50
Price-Earnings Ratio	Def
Market Cap	$178.1 million
Avg. Daily Volume	53,318
Inst. Ownership	34%
Dividend Yield	Nil
Beta	5.2
Def = Earnings Deficit. Source: Market Guide, Zacks, Company Reports

Witness' eQuality product provides multimedia and analysis, letting companies record and evaluate customer experiences through multiple media, such as telephone and Web chat. "By capturing both voice and computer desktop activity and synchronizing them ... a company can observe and analyze complete customer interactions as they actually occurred," according to Witness.

The company's multimedia analysis systems have caught the attention of major clients, including American Express, Bank of America, Federal Express, Federated Department Stores, General Motors, WorldCom, Merck and Southern Company.

Those customers seem satisfied. In the third quarter, existing customers accounted for 63% of the company's total revenues. After adding 18 new customers in the quarter, Witness boasts 302 clients, with 8% of third-quarter revenue coming from outside the U.S.

Witness the Growth

While the company has yet to post a profit, revenues are growing at more than 50% a year since 1998 and the company says it can grow revenues at a 35%-to-40% clip in 2002.

The company has won its share of battles. "Witness is outperforming its peers through a combination of diminished competition, strong execution and the solid value proposition of its product," notes SunTrust Robinson Humphrey software analyst William Chappell.

Witness Performance Witness Systems on Its Way to Profitability
Year	Sales (millions)	Earnings**
1998	$13.30	$(0.75)
1999	$22.97	$(1.37)
2000	$43.91	$(0.17)
2001*	$61.10	$(0.01)
2002*	$82.00	$0.17
*Estimates. **Per Share. Source: Company Reports, SunTrust Robinson Humphrey, Thomson Financial

More importantly, the company appears to only have scratched the surface of its potential, even with existing customers. "The company estimates it has penetrated less than 20% of its existing customer contact centers," adds Chappell. He rates Witness Systems buy and his firm has not provided banking service to the company.

The potential to build on existing relationships was seen in the third quarter as Witness expanded its relationship with Verizon Wireless in a deal that should add about $3.5 million in revenue and, according to Chappell, should give Witness an easy "entry point into parent company, Verizon Communications."

Even in a sluggish economic environment, Witness was able to ink four new deals in the third quarter of more than $1 million each -- including Verizon Wireless -- as revenue increased 29% from the same quarter in 2000.

The other appealing quality of the company's revenue base is the distribution between sales and services. While software licenses comprise 63% of the company's total revenues, services -- a more likely recurring revenue source -- generate nearly 40% of total revenues.

Given the company's ability to generate new sales in a tough economic environment and the continued maturity of its cost structure, investors should see a profit in 2002. Consensus estimates call for it to earn 16 cents per share in 2002, suggesting the company is trading at a price-to-earnings ratio of 47 times. That's not cheap, but for a company that is growing at nearly 40% per year and has shown discipline in spending, it isn't unreasonable.

Speaking of expenses, Witness has shown good discipline. In the third quarter, the company reduced every expense item, excluding a $600,000 bad debt charge. Its agility showed last month as Witness quickly cut back on marketing expenses in the wake of the Sept. 11 terrorist attacks.

Finally, the company is well positioned if the economic slowdown continues. While it has proven it can sell product as the economy slows, the $61 million in cash and investments on its balance sheet is a security blanket. And, unlike many smaller companies, its cash level increased sequentially in the third quarter.

Witness the Risk

Like most names featured in the Bottom of the Barrel column, many of the risks are obvious. Remember, first, this is a company that has yet to post earnings, is growing at breakneck speed, operates in a competitive industry, and trades only about 50,000 shares a day. And, while the company's growth rate is impressive, the stock is not cheap.

Hence, the stock will be volatile, a protracted economic slowdown could hurt the company's growth prospects and, while Witness is a leader in its business, software is only as good as the latest upgrade and a competitor that comes up with a better measurement system could cause Witness to struggle.

That said, the company appears to be poised for solid performance in the coming year. "We believe the company's near-term visibility is strong and we would not be surprised to see growth rates in excess of 40% if the economy improves," notes Chappell. "Witness appears to be sailing smoothly despite a stormy environment."

We give Witness System a hefty three barrels for its innovation, ability to grow even in tough times and its solid balance sheet. Patient investors should witness something that has become rare in technology start-ups -- a rise to profitability.

Stirring the Barrel

Beginning this week, we look back at previous Barrel stocks. In the following table you will see the company, the "Barrel ranking" and performance data.

Looking Inside the Barrels From half-full to half-empty
Barrel Rating	Company/Ticker	Date of Mention	Mention Price*	Current Price	Pct. Change
	Hibbett Sports (HIBB:Nasdaq)	24-Oct-01	$30.33	$27.10	-10.65%
	Met-Pro (MPR:NYSE)	17-Oct-01	11.16	11.20	0.36%
	Bridgford Foods (BRID:Nasdaq)	10-Oct-01	13.18	13.75	4.32%
	Quixote Corp (QUIX:Nasdaq)	3-Oct-01	21.44	22.03	2.75%
*Average price on date of mention Source: TSC Research

In the coming weeks, we'll provide more color on the performance and updates on the stocks as news warrants.

For an explanation of our barrel rating system, see our recent description.

Do you have candidates for bottom of the barrel? If so, shoot me an email with the company name, why you think it qualifies and your full name and hometown. If we profile your suggestion, we'll send you a TSC gift to commemorate your pick.

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