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Wednesday, January 6, 1999

An Investment Opinion
by Louis Corrigan

JDA Software's Hard Landing

When a top-performing company hits a rough spot -- and its stock gets crunched -- it's natural to wonder if the market is flashing a bargain sign. The case of JDA Software Group (Nasdaq: JDAS), however, suggests the risks endemic to this bottom-fishing strategy, at least in the short term. That's because business momentum works both ways. When a company that has been hot begins to cool down, you better know something that others don't because the worse case scenario that the market begins to discount into the stock price is often just a few quarters away from becoming reality.

Shares of JDA today sank 26%, losing $2 15/32 to $7 1/16 after this provider of enterprise software that helps retailers like the Gap (NYSE: GPS) and Williams-Sonoma (NYSE: WSM) track inventories and purchase orders announced late yesterday that Q4 results would come in way off track. An unexpected and dramatic shortfall in U.S. software license revenue is now projected to produce a Q4 loss of $0.08 to $0.11 per share. That's well shy of the consensus earnings estimate calling for a gain of $0.18 per share. Analysts from Prudential, Piper Jaffray, and Hambrecht & Quist rushed to downgrade the stock one notch, to a "neutral" or "hold" rating, while slashing estimates.

JDA's numbers were so ugly that CEO Brent Lippman was handed his walking papers. Co-chairmen and co-founders James Armstrong and Frederick Pakis have now returned as co-CEOs on a full-time basis in what the company sees as a long-term arrangement. In yesterday evening's conference call, they said they're now in "analytical mode," trying to make sense of the large number of deferrals experienced in what had appeared to be a strong U.S. pipeline. As CFO Kris Magnuson put it, software sales, which are always concentrated in the last couple of weeks of the quarter, "fell apart on a day by day basis" as the quarter came to a crashing thud.

Though Q4 sales should come in around $33 million, up 10%, the gains resulted from lower-margin consulting, maintenance and other services. Crucial software license sales plummeted to $7.5 million from $14.6 million a year ago. While results were especially ugly in Europe, where JDA did just $1.3 million in license revenue versus $5.4 million last year, that dip was largely anticipated. The year-ago period included a huge $3 million deal. Plus, JDA's European sales have been deteriorating all year, something that led to the November 15 hiring of Colin Wyatt to beef up management of the European sales team.

North America was the real shocker: U.S. sales collapsed to $3.6 million from $5.8 million in Q4 1997 while Canadian sales dropped to $0.4 million from $0.6 million. U.S. license deals had been the year's major bright spot, rising 130% in Q3 and 91% in Q2. Magnuson said the new management team will be interviewing sales personnel to figure out just what happened.

She said that JDA boosted the number of U.S. sales reps from 11 to 17 during 1998 and that only one representative left the company, so turnover wasn't the issue. Magnuson also indicated that the lower license fees weren't due to losing more deals to competitors such as giant enterprise resource planning (ERP) players like SAP (NYSE: SAP) or PeopleSoft (Nasdaq: PSFT), the latter of which has a new merchandising system that has not yet hit the market. She added that JDA didn't suffer unexpectedly in Europe from retail software competitor HNC Software (Nasdaq: HNCS), but she wasn't yet sure about the U.S. With much talk that the Y2K issue is impacting sales at major ERP outfits such as SAP, which reported unexpectedly weak Q4 results on Tuesday, Magnuson was asked whether that played a part in the JDA's lame results. She said that's "part of the puzzle that we are not prepared to answer today."

For the year, JDA's software license revenue increased a meager 5% to $44 million, with domestic fees up a sharp 59% to $26.6 million. International software sales declined 33%, due both to Europe and to a slowdown in the Asia-Pacific market, where sales fell to $1.8 million in Q4 from $2.6 million last year.

JDA also made two other noteworthy announcements. First, due to new SEC rules regarding accounting for in-process R&D, accountants Deloitte & Touche are now telling JDA it can write-off only $17 million of its $44 cost of acquiring Comshare's (Nasdaq: CSRE) Arthur line of decision support tools, rather than $40 million as previously announced. This change is a non-issue from a cash flow perspective, but it means that future expenses will rise by $575,000 per quarter due to the increased amortization of goodwill. Also, the Q2 loss due to the acquisition charge will be restated, from $0.87 per share to $0.24, while Q3 earnings will be cut to $0.15 from the $0.17 reported due to the amortization charge.

More important, JDA has altered its late August deal with troubled ERP suite provider Baan (Nasdaq: BAANF). They had formed a joint venture selling a combined software solution to vertically integrated retailers. The companies are now working on a new marketing arrangement because, as Magnuson said, the joint venture structure created confusion with customers about who was really standing behind the product.

In the short term, all of this looks like very bad news for JDA, which in 1997 was the leading supplier of retail/wholesale-specific software applications, with 4.6% market share, according to a report from International Data Corp. Revenue soared 92% in 1997 on a 73% increase in software license sales, good for a 48% jump in EPS. JDA had appeared well-positioned, so much so that investors bid the stock up to $39 last April. That track record made me suggest that JDA was worth a look last August after it fell to $15 and again in October when it sank to $7 3/4. Yet with co-founders Armstrong and Pakis only beginning to get a handle on the situation and the whole sector being rocked due to Y2K-related uncertainty and other concerns, it wouldn't be shocking to see JDA fall a little closer to its current $3.57 per share net cash level as investors wait to see just what the problem is. On the other hand, a management change is often the first step in a turnaround.

U.S. investors interested in listening to the JDA's conference call should dial 800-475-6701 (access code: 426478). The replay is available through January 19.

Related articles:
-- Daily Trouble, 08/25/98: JDA Software Group, Inc.
-- The Evening News 10/21/98: JDA Software and the ERP Washout

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