“This Is What You’ve Trained For All Your Life”

The recession may not be all kicks, but it's not short of challenges for a CFO. Here's a view of the ups, downs, and demands through the eyes of th...
David McCannSeptember 10, 2009

It’s a rare CFO who has had much fun during the recession. Earl Fry, who heads up finance for Informatica, a vendor of enterprise data-integration software, certainly isn’t one. And that’s despite the possibility that the economic ills ultimately will prove to be quite fortuitous for the company.

If there’s one thing the recession has done, it’s forced companies to rethink processes in a quest to wring out efficiencies. That provides hope for many software firms. Behooving Informatica, companies long afflicted by inertia in their approach to accessing their myriad data silos may at last take a new tack, Fry says. There is pent-up demand — especially, he believes, in the financial-services sector, which comprises about 20% of the company’s business.

But there has been no shortage of angst along the way. In the depths of the downturn, the company’s previously strong growth pace moderated considerably as large orders fell off. A planned expansion in Europe stalled. A convertible bond offering made in 2006, with the first put option scheduled to come due the year after next, was transformed from a brilliant strategy to a potential bust as Informatica’s stock price tumbled.

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Fry, Informatica’s CFO since 1999, actually noticed the winds of change back in early 2007 and took steps then to slow down the company’s spending. He credits his membership on the board of Central Pacific Bank in his native Hawaii with helping to provide him with a bird’s-eye view of the unfolding financial crisis.

After the economy melted down last fall, it was gut-check time. Fry recalls going home one evening in late 2008, sharing a bottle of wine with his wife, and feeling somewhat depressed over the many decisions that needed to be made based on “very imperfect” information about business prospects. Finally he said to himself, “Buck up, Fry — this is what you’ve trained for all your life.”

Following is an edited version of Fry’s interview with, in which he touches on lessons learned from the recession, prospects for recovery, his company’s changing liquidity picture, the upcoming rewrite of revenue-recognition rules, and more.

A lot of your business is with financial-services organizations. What are you seeing in that sector?

In the U.S. banking environment, we actually started to see customers being a little more cautious on spend and not being as willing to do large transactions in the first half of 2007. Looking at those early indicators from our sales pipeline, and with what I was being exposed to on the bank board, I said, wait a minute. Things could be setting up for a very tough environment, at least in the United States, for some time, so you’d better be cautious about how you’re deploying resources.

EarlFry1“Don’t get too caught up in the income statement and looking at EPS growth.”
Informatica’s Earl Fry

As early as March of this year, we started to see signs of our sales pipeline building in domestic — though not international — financial services. Certain customers, typically the larger, more successful, better financed ones, know they’re going to survive and be the consolidators, so they’re getting back to business. Our domestic financial-services business had double-digit growth year over year in the first quarter, and even greater growth in the second quarter.

By consolidation, you’re talking about banks that are looking for acquisitions and therefore will have to integrate their data with that of other banks?
Yes, and that’s already happening, of course. For example, both JPMorgan and Washington Mutual are customers of ours, and guess what — JPMorgan is spending more on data consolidation and integration now than it was a year ago.

Were the lessons learned from this recession different from those learned from the dot-com bust nine years ago?
Fundamentally those were very different downturns. For the dot-com bust I don’t even use the word downturn, because it wasn’t broad-based. There was a technology bubble, it burst, and there was a retooling and retrenchment primarily in the technology and software business.

This recession was caused by a massive real estate and financial-driven bubble that built up over the last seven or eight years, or you could even say a couple of decades. The magnitude of this recession is significantly greater.

But one lesson that applies to any downturn is that you have to plan for it. Things are never as good as they seem in an upturn, and if you think about it that way, then you’ll be prepared for a downturn and will be able to continue investing in your products and people. Informatica was formed in 1993 around the building of data warehouses. From 2001 through 2004 we stopped growing, but during that time we broadened the technology so it could perform in real time and access more data types. If we had stayed as just a tool for automating data warehouses, even when a recovery happened growth prospects would not have been great.

What are the keys to managing finance during an economic slump?
Always pay attention to your balance sheet. Cash flows are important. Don’t get too caught up in the income statement and looking at EPS growth — that’s important, but doing that at the expense of cash flows or losing flexibility on your balance sheet is risky.

Also, make sure you’re working only on the most important things. In the IT organization, the big projects that will take many years to show some kind of return — you can’t do those now. Invest only in things that drive near-term efficiencies.

And, as I mentioned, look for the early warning signs. When things are good, you’ve got the hiring spigot wide open. When you decide to shut that off, it takes a while to ripple through the organization. So the sooner you can start moderating that, the better off you are.

When we saw things starting to change in early 2007, we had to modify the plan we had just put in place at the start of the year. We made more on-the-fly changes to our operating plan than I’ve ever done in my 25-year career in Silicon Valley. We had been planning to grow our operations in Europe a lot more. What was happening in the U.S. was broad-based, so we knew there would be a ripple effect. So we said: let’s moderate our growth expectations and not put our resources there.

On the other hand, our Latin America business was starting to grow nicely, exceeding its numbers, and we didn’t see the same kind of warning signs, so we actually put disproportionately more resources there.

What were the early warning signs you saw in the United States? Were they metric-based macroeconomic issues, or more micro ones, like customers taking a little longer to make decisions or looking for more software options for the same amount of money?
It was a combination of those things. If you rely on any one metric to the exclusion of others, you’re going to get burned. If you listen only to what your customers and sales force say to you, you will get burned 100% of the time. They may be right in how they understand the world to be at that particular point in time, but that may not help you in forecasting sales six or nine months out.

The data points we were getting from our field sales team were all flashing green except for one vertical in one region: U.S. domestic financial services. Even there we had a good first quarter in 2007. But the shape of our forecasted pipeline was anomalous, with meaningfully fewer large transactions. What did that mean? By itself, maybe nothing. But being on the bank board and understanding more about the bubble that was cresting in the financial and credit markets, I took that data point as telling me to be careful.

As a CFO, you’ve got to take every data point you can and form your own picture of the world. I do have a network of other CFOs, but you have to take what they say with a grain of salt. The picture is going to be different in different industries and different parts of the cycle.

Did you have to keep an eye on the balance sheets of your customers because of the credit crunch, or change your credit terms?
We were mindful of it, but only for a very small number of accounts did we change credit terms. By and large we deal with large global companies. Some of them may slow payment down a bit, but I think we had three write-offs in the last five years, all very small.

What’s your view of the prospects for a general economic recovery, and what are you doing from a finance standpoint to prepare for that?
I think people should be cautious about a recovery. I think it will be longer before it happens and slower than any we’ve seen in the past. It’s hard to differentiate whether you’re seeing pick-up now from the stimulus, or inventory corrections.

It’s very important for CFOs not to get too carried away with near-term positive or negative data points. Continue going forward with the disciplines you put in place over the last several quarters. There’s no reason to stop the ruthless prioritization. Investing in people and retention is critical — that would be the first thing I would spend on.

But — and this may not be very objective — I think tech companies are reasonably well positioned coming out of this. Our biggest challenge at Informatica has always been overcoming customers’ inertia, convincing them that there’s a new and better way of doing things. People like to do things the way they’ve always done them, even if it’s more expensive, and slower, and riskier. From a selfish perspective, I can’t think of a better event or series of events to break inertia than a very broad, deep recession that is challenging organizations to do things differently. Doing things the way you’ve done them for the last 10 or 20 years just isn’t going to cut it.

Have you reordered your capital-raising priorities?
We have a pretty simple capital structure. We have no bank borrowings. It’s not rocket science, but I subscribe to the idea that you raise money when you don’t need it, when people are willing to give it to you.

Back in 2006, we issued a 20-year convertible bond for $230 million. We still have $201 million of that outstanding. In the midst of the credit crisis in the fourth quarter, the bonds were trading well under par, and we bought back some of them under par; we were generating cash flow, so we could afford to do that.

I do have to decide what to do. The first of the put options on the convertible is due in March of 2011. I’ll need to decide whether the timing is right to refinance that. The conversion rate happens at $20 a share, so given that we’re trading in the high $18s now, I don’t think we’re at very high risk. Nine months ago, I was planning my financials assuming I’d have to repay all of that.

So have your views on your liquidity changed?
Absolutely. Two years ago, I wasn’t worried about the 2011 put option on the bond at all, thinking we’re going to blow past $20 a share and it’s all going to get converted to equity. I was thinking, wasn’t I smart for raising money in 2006 at 3% and being able to invest it at 5%? Then nine months ago I was saying, well, I haven’t spent all the money, and it’s a good thing, given where the credit markets are. I need to make sure I’m keeping $230 million on hand — at that point in time — in addition to whatever working capital I needed.

Fast forward to today, and I’m somewhere in between. Clearly we’ve got more flexibility. The credit markets are in much better shape. It’s going to depend on our stock performance as to what kind of flexibility I have with either refinancing the bond or allowing it to convert.

Switching topics, is what Congress doing on health-care reform on your radar?
Yes. The health-care vertical is consistently 10% or more of our business. Change will focus on digitizing information and more integrated access to and views of data. There’s a significant role we can play there. I think that’s a 2010 and 2011 phenomenon for us, but I am sure we will benefit from it, and we are looking at making sure we have more resources deployed to the health-care vertical.

Earlier you said you put more focus on the balance sheet than EPS. But we noticed that after your second-quarter results were announced, there was disagreement in the analyst community on whether to rate your stock a “buy” or a “hold.” Do you concern yourself with that?
I pay attention to analysts to make sure they’ve got things factually correct. I do not pay much attention to whether an analyst has a short-term hold rating or buy rating. Their motives are very different from mine. I make sure I’m communicating consistently to them, and more importantly that I’m communicating consistently to our shareholders and prospective shareholders.

So you don’t specifically take actions with the design of influencing the stock price? Or is the stock price just a by-product?
It’s a by-product. You can influence things in the short term, but the results are going to speak for themselves over time.

One analyst recommended Informatica stock because of consolidation in your sector and the supposed possibility that you could be acquired by Hewlett-Packard or Oracle. Could that happen?
I can’t tell you how many times I’ve answered questions like that over the last five years. But I can’t write business plans for somebody else. I know we are focused on a very good segment of enterprise software, but I can’t predict whether [Oracle CEO] Larry Ellison will wake up tomorrow and decide to go shopping. The sell-side analysts spend a hell of a lot more time thinking about it than I do.

Revenue recognition is always a big topic for software companies, and FASB and IASB are working together on a rewrite of the rules. Does it cause you much worry?
We’re monitoring it. There’s a very big difference [between U.S. GAAP and International Financial Reporting Standards]. In the United States, there are hundreds of pages of guidelines for software revenue recognition. In IFRS, there are one or two dozen. If you asked the average institutional investor whether software companies should get more flexibility in how they recognize software, I think the answer from every single one would be, “I’m not sure I like that.”

There needs to be more thought, and I think it’s going to take some time, but I hope we do get to one standard one day