Capital Markets

Bigger, Not Richer

Acquisition-fueled revenue growth masks lackluster cash and profit performance by mid-sized software companies.
David McCannJune 10, 2009

Editor’s note: To download a Microsoft Excel file containing the full results of the CFO Midcap 1500 Software Industry Scorecard, click here.

The mid-market software sector managed to eke out 4% revenue growth in the first quarter over the same period in 2008 — a seemingly positive result amid abysmal economic conditions, but one that was driven largely by acquisitions rather than improved cash performance.

Among the 41 software companies in the CFO Midcap 1500 whose first fiscal quarters ended March 31, profits plunged by half as operating cash flow fell off by 5% and money tied up in working capital swelled by 4%.

Cash earnings per share — defined as operating cash flow divided by diluted shares, a measure of funds available to invest in the company or pay dividends — dipped a penny, to 24 cents from 25. But even with that decline, cash EPS was 5 cents higher than it was in the first quarter of 2007.

A number of the trends show up in the quarterly results of Taleo Corp., a vendor of human capital management software. The company’s top line jumped 34% over last year’s first quarter, from about $36 million to $48 million. About half of that increase, according to CFO Katy Murray, was attributable to the company’s July 2008 purchase of Vurv Technology, another talent-management solutions provider. But the acquisition was also the main culprit in a net quarterly loss of $2.2 million, compared with a $561,000 profit a year earlier.

The big hit came in amortization charges absorbed in the Vurv deal, noted Murray. The adjustment for depreciation and amortization on Taleo’s quarterly cash flow statement ballooned to $6.7 million from $2.4 million in the year-ago quarter. Backing out that line item as well as stock-based compensation, another non-cash expense, the company actually made $5.6 million of “real cash profit” in the quarter, Murray told

“Those expenses drove the loss, not the fundamentals of the business,” she said. “There is still very good demand for what we sell. Did we do as well as we would have if the economy wasn’t challenged? That’s hard to say, but we’re the leader in our space, and at times like this the strong tend to get stronger. We’ve seen more business close — our ‘win’ rate has gone up.”

Murray also credited a 95% renewal rate on software subscriptions, and a quarterly billing cycle that she said makes collections easier in these tight times than expecting customers to pay for a whole year up front, as some software-as-a-service companies do.

To be sure, the acquisition helped add $8 million to the company’s net working capital load, and sales, general, and administrative expense as a percentage of revenue climbed by 11%. Still, Taleo’s cash EPS was a healthy 43 cents, up from 28 cents in last year’s first quarter.

Taleo’s purchase of Vurv was a relatively small one, costing $37.5 million in cash and 3.8 million shares of common stock. A much bigger deal was closed last summer by Ansys Inc., a maker of engineering software, which acquired Ansoft Corp. for $387 million in cash and $423 million worth of stock.

The purchase saved Ansys from a top-line decline, but not from a profit falloff. The company’s total revenue grew by only $6 million from the first quarter of 2008, but Ansoft-related software license and maintenance revenue totaled more than $16 million. Overall growth slowed markedly from a year ago, when quarterly revenue shot up by 25% over Q1 2007.

Ansys remained a star profit  performer — its 18.1% margin was second-highest among the 41 companies — but net income fell by almost $5 million, to $21 million. The decrease was a function of the accounting related to the Ansoft acquisition, Ansys finance chief Maria Shields told Notably, amortization expense for intangible assets grew to $12.9 million, from $7.2 million in last year’s first quarter. Shields also pointed to interest expense for a $355 million bank loan that helped finance the deal.

Yet the company’s operating cash flow soared in the quarter to $51 million, from $37 million a year ago, which pushed cash EPS up by 24%, to 59 cents.

“The Ansoft purchase was cash-flow positive, but our legacy business also had a strong cash-flow quarter, driven largely by discipline around cost controls that we put in place late in the fourth quarter as we started to see business slow down,” Shields said. The company implemented the first phase of a 6% head-count reduction that’s expected to save about $9 million this year. It also froze salaries, trimmed marketing costs, and decreased its use of consultants, among other savings tactics.

Also having a big cash impact, Ansys was able to recognize $6.7 million in collected receivables in the quarter, whereas in the year-prior period accounts receivable fattened by $5.5 million.

Meanwhile, a single acquisition had a profound impact on the overall results of the mid-market software sector. In a $2.8 billion cash-and-stock deal in May 2008, Macrovision Solutions, which provides software for digital entertainment products and services, purchased Gemstar-TV Guide International, a licensor of interactive program-guide technology, publisher of TV Guide magazine, and distributor of TV Guide Network and TVG Network.

Mostly because of the acquisition, Macrovision’s first-quarter revenue entered a new stratosphere, moving up to $111 million from $30 million, while cash EPS more than doubled, to 17 cents. But profitability collapsed, from a $5 million net gain to a $42 million loss. The two biggest factors: The company sold off the TV Guide products during the quarter, creating a $36 million loss from discontinued operations; and amortization expense, most of it related to the Gemstar acquisition, rose by $21 million.

Some other mid-market software companies that made notable acquisitions were able to boost both revenue and profits, as well as cash EPS.

Advent Software, which provides a range of products for institutional investors, acquired Tamale Software last October. The purchase was largely behind a combined $5.2 million boost in first-quarter operating expenses and cost of revenue, the company said in its 10-Q report. But it also said adding Tamale helped Advent increase its revenue by 18%, from $61 million to $73 million. Net income rose by 42%, to $6.2 million, and cash EPS improved to 55 cents from 35 cents.

And Dynamics Research Corp., a provider of engineering and other technical solutions to federal and state governments, bought Kadix Corp., a specialist in high-end services for homeland security. The deal was responsible for about two-thirds of the company’s $13 million revenue gain. The bottom line was plus $1.8 million, compared to a year-earlier loss of $5.3 million, while cash EPS leaped by 84 percent to 35 cents.


2009 Q1 CFO Benchmark_Software


What Is the CFO Midcap 1500?

The CFO Midcap 1500 is an index created by CFO. Based on publicly reported data provided by Capital IQ, it consists of publicly traded companies headquartered in the United States that have annual revenues ranging from $100 million and $1 billion.


What Is Cash Earnings per Share?

Cash EPS is calculated by dividing a company’s operating cash flow by its diluted shares outstanding.


Why Is Cash Earnings per Share Important?

Cash EPS is a metric that measures how much money a company produces, over a given period, that is immediately available to be returned to shareholders or reinvested in the company’s operations. The metric can be used to benchmark a company’s cash-generation performance relative to others within its industry, to those in other industries, or to the midcap index as a whole.