Say what you will about Wall Street and its insatiable appetite for bigger and bigger numbers. When it comes to corporate profits, quality sometimes still trumps quantity.

It's an issue that

Siebel Systems


could face as it reports its second-quarter earnings July 18. Siebel is regarded by Wall Street as a top-notch firm that will make its numbers despite the tough economy -- the lack of a profit warning last week would seem to confirm that opinion. But at least one analyst is questioning whether those numbers will be as good as they look, considering how Siebel achieved its results last quarter.

The reason, says

Wedbush Morgan Securities'

Nathan Schneiderman, has to do with software "swaps" the company engaged in during the first quarter, as well as a high percentage of revenue coming from a trio of customers during that period. Some analysts have characterized Siebel's ability to make its first-quarter numbers as a "Herculean" feat, but Schneiderman points to these issues as a potential Achilles' heel on the software giant.

"I don't think Siebel is going to miss on the top or bottom line," says Schneiderman, who has a long-term attractive rating on Siebel. "But where we might see problems in the quarter is if people start paying a lot of attention to the quality issues. Does the company pull out all the stops to make the quarter and then issue lower guidance? Those are my concerns." (His firm hasn't done underwriting for Siebel.)

In its 10-Q filing with the

Securities and Exchange Commission

detailing its first-quarter operations, Siebel said $38 million of its software sales originated with customers from whom Siebel "purchased goods or services ... at or about the same time as the software transactions." In other words, Siebel scratched some backs, and got its own back scratched, during the first quarter.

In and of itself, there's nothing wrong with that, and Siebel routinely engages in these so-called swaps. But during the first quarter, swaps accounted for 11% of the company's total software license revenue. That, apparently, was a big enough chunk to warrant the disclosure of the dollar amount in its federal filing. (Interestingly, the last time Siebel disclosed the amount of its software swaps was for the third quarter of 1998, during the last notable period of economic weakness. Then, it attributed $10.8 million, or 14%, of its software license revenue to swaps.)

What becomes problematic is how Siebel accounted for the other side of the deal in these swaps. While it recognized the $38 million in revenue it received from the swaps upfront, Schneiderman says it amortized, or spread out over time, the cost of what it paid or gave its customers in return. That means first-quarter earnings weren't offset by the cost Siebel incurred to bring in the revenue that helped lift the bottom line.

That doesn't exactly qualify as funny accounting, but it could be regarded as aggressive.

"If you have two sides of a transaction and they're related, they should be recognized equally during the same period," says Michael Thomsett, an accountant and author of

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Mastering Fundamental Analysis

. "It sounds like they're trying to show higher earnings this year."

Thomsett says Siebel's accounting is fine -- as far as accounting goes. But like Schneiderman, he says the company's methods do put some haze over actual results when performing fundamental analysis of its numbers.

"It might be fully legitimate as far as the SEC and GAAP

Generally Accepted Accounting Principles is concerned, but for shareholders, it might not be as straightforward as they would like it to be."

A Siebel spokeswoman didn't respond to a message seeking comment for this story.

Siebel Systems
A good first quarter gave it some spring

"The effect of all that is that the revenue increases significantly the bottom-line benefits on the income statement," Schneiderman says. He estimates that the large amount of swaps in the first quarter added 2 cents to 3 cents to Siebel's earnings, helping it beat by one penny analysts' 14-cent estimate during the first quarter.

Which again, is all fine and good, except that the cost of those swaps will eventually have to hit the bottom line, as costs always do, as they're amortized over time. That means the boost in earnings from the first quarter will be felt by charges to earnings in the other periods down the road.

"You can stretch to make the quarter once, and you can stretch to make it twice, but eventually, you're going to see the effects of that unwind," Schneiderman says. (Here again, it's worth noting that the economic weakness in 1998, when Siebel last disclosed swap-related dollar amounts, was relatively short lived.)

Schneiderman's second concern is a concentration of revenue. By his analysis, just three of Siebel's customers accounted for $84 million, or 25%, of the company's $335 million in software license revenue. With larger deals becoming harder and harder to close in the software industry, that kind of concentration should be a concern to Siebel's investors.

None of this is to say Siebel is not a juggernaut investment. Since its

IPO in 1996, its stock has appreciated more than 2,000%. But when times get tough, even the best companies sometimes have to pull out all the stops to get things done.

"One of the reasons Siebel is a great company is that it did execute better than its competition in a very rough economy," Schneiderman says. "But the flip side is that if you look under the covers, last quarter was not as strong as some people believed it was, and I think we have the evidence to support that. We think we're right to point out issues investors should look at."

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