Software Suppliers At a Loss

By John McCormick Print this article Print

Some software suppliers seem stuck in reverse. How to protect yourself for the long-term.

Consecutive quarterly losses for several major software companies now stretch back two, three, and—in some rare cases—six or seven years. The result: Large, medium and small corporations have to seriously question whether some key suppliers will survive long-term.

PDF Download For instance, manufacturing logistics expert Manugistics reported a third-quarter loss of $26 million, its eighth straight loss; supply-chain software pioneer i2 Technologies reported a preliminary fourth-quarter loss of $12.4 million, its 11th straight quarterly loss; and electronic procurement specialist Ariba reported a $55.9 million first-quarter loss, its 15th consecutive unprofitable quarter. That's almost four years without posting net income. Others, such as 6-year-old E.piphany and 7-year-old Agile, have never posted a profit.

Times are tough, with spending on information technology flat or down for most of three years. As a result, stakes are high for companies that must come out of the recession with reliable operations.

After all, once a commitment to a software platform is made, "it's difficult to disengage from it," says Gene Trudell, managing director of information technology services at U.S. Steel.

Buyers make big commitments to their software vendors. Many sign multiyear, multimillion dollar contracts that include the software license as well as ongoing maintenance and training. Before a package is installed, the software buyer and seller often spend months customizing the application to meet the customer's particular needs. And software project managers count on their vendor to be there with upgrades when future business requirements dictate the need for more powerful features.

However, industry analysts say it is only a matter of time before the profit-challenged are unable to sustain continued losses. Consultancy Gartner Inc. estimates that as many as half of the 1,500 enterprise software companies operating today could be out of business by the end of 2004.

How can customers pick out the survivors?

Profitability is paramount. But AMR Research and Gartner say managers also should study a vendor's balance sheet, for signs of excessive debt; watch to see if the company continues to win new clients; and watch for defections from the existing set of customers.

Take the cases of i2 and Manugistics. I2's year-end loss totaled a staggering $1 billion. In addition, a Securities and Exchange Commission probe into accounting irregularities has forced i2 Technologies to re-audit its financial results for all of 2000 and 2001 due to what the company says were "revenue recognition" problems. I2's stock at the end of January was trading at just about $1, which said much about investors' view of the company's prospects. Stock exchanges confirm that view, with their regulations. I2 came close to being delisted, but avoided that by moving to the NASDAQ Small Cap Market effective Jan. 30.

Meanwhile, Manugistics has averaged about $25 million a quarter in operating losses for the past year. The company ended its most recent quarter with $127 million in cash, down from $209 million a year ago.

I2 and Manugistics say buyers need to look past their income statements.

"We're in good position," says Raghavan Rajaji, Manugistics' chief financial officer. "We see new business, we're engaging sales prospects, we're doing demos." One of the company's strengths is its installed base, which includes such signature clients as AT&T, Coke, DuPont and Ford.

What does this mean for other would-be clients? If times really do get tough for the software supplier, its installed base is sure to attract potential suitors. Liquidation is not likely.

For its part, Janet Eden-Harris, i2's chief marketing officer, says preliminary fourth-quarter numbers show the company with revenue of $120 million, beating analysts' forecasts. She also says that, excluding restructuring charges, the company had a profit last quarter of 2 cents per share. But just as important as profits, i2 has $457 million in cash or investments easily converted to cash.

Once again, says Mark Gomes, director of investment research services at AMR Research, "cash is king." During the late 1990s, many companies used any number of financial instruments to raise cash—cash hoards now seeing them through the bad times.

Cash is also a reason people do business with a company like Agile, which has never reported a profit. The product-lifecycle management software vendor reported a fiscal second-quarter loss of $6.6 million on revenue of $17.5 million. Yet the company has cut operating expense from $24 million to $19 million—leaving R&D relatively untouched—and has almost $94 million in cash and equivalents.

"A lot of companies have various degrees of stability based on their cash," says Cameron Steele, an analyst at RBC Capital Markets. He says software companies like Agile, with no real expenses except for personnel, can live off their cash reserves for an extended period. Says Agile's President and Chief Operating Officer Jay Fulcher, "no one questions our viability."

One positive sign to watch for is whether a company's revenue from software licenses is growing, a sign of health.

Customers also can protect their investments by securing access to a vendor's source code, and only going with vendors that have strong cash positions and extensive third-party support. After all, even if a software vendor is acquired, the acquirer will push clients to its software. Customers may be left software that won't be developed further.

What You Should Look For: Financial Warning Signs

Sustained net losses
Profit is paramount. To remain in business long-term, a company has to take in more money than it sends out.

Diminishing cash
Without cash, a company can't pay its bills. If cash keeps dwindling, watch out.

Decreasing license revenue
Decreasing revenue from software licenses can indicate a company in trouble.

Lots of debt
Compare long-term debt to shareholders' equity. If lenders have put as much into company as shareholders, be worried.

This article was originally published on 2003-02-01
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