The heavy discounting by SAP and Oracle make it hard to beat them on price, and slowing growth in IT spending for software means fewer deals to go around. Lawson's loss in the most recent quarter is another point of evidence.So, Debes wrote to me yesterday, concerned that I might not have "the complete story on Lawson Software." He then continued (bolding is mine):
Lawson acquired Intentia in April 2006. Both companies were of comparable size, but each served different markets. Lawson was focused on the Americas and services-based organizations while Inentia was focused on Europe and manufacturing & distribution organizations. Because of the different industry focus, we decided to keep our existing industry focus and discrete products - naming the former Lawson suite S3 and naming the former Intentia suite M3. There were plans to cross-sell the applications into each others' geography and customers and that is working fairly well.I have bolded the key point above, which is the issue of recognizing revenue in a contract or subscription business. You receive software license contract (or maintenance contract dollars) all at once, but you deliver services for the contract through the year. At the beginning of the contract period, such businesses accrue revenue on the balance sheet and then credit sales month by month throughout the life of the contract, so that the GAAP principle of matching revenue with expense is maintained.
On a non-Gaap basis, where we exclude certain one time, non-cash accounting treatments, the newly combined company was profitable in Q1 (June - Aug 06) and again for the second quarter (Sept - Nov 06). Pre-tax, non-Gaap operating income - the appropriate measurement of management's performance and one that is used by all of the Wall Street analysts, was 3% in Q1 and 6% in Q2.
Our transition year accounting can be difficult to understand. We did miss our license guidance in Q1 and Q2 primarily because during our first year of integration, we must defer approximately 50% of our license revenue. That deferred revenue goes to our balance sheet and will come back into income in our second year, as we deliver the projects. This means that next year, we will automatically receive a $8m - $10m license revenue bonus every quarter on our P&L. Because of the acquisition, we did not have an opening deferred license revenue balance, but if this was a normal year, with all other activity at the same level of performance, our license fees and our earnings would be $32m-$40m higher this year - resulting in revenues of approximately $780m and operating income of approximately $60m. Because of the transition and timing issues associated with our acquisition, we must wait until our next fiscal year (June - May 2008) to reap these financial statement benefits.
On the whole, the business is sound. Every quarter we engage in competition against SAP and Oracle and every quarter we come away with 35-45 new accounts. We are growing our sales force and as we do, those number of wins will continue to increase.
Lawson offers a legitimate alternative to customers who don't find a suitable solution or level of partnership with the two larger ERP vendors. We are more focused on our target markets and are also more focused on developing an intimate relationship with our customers.
Of course, Lawson has been accounting for its sales in this way long before the Intentia deal. But Debes appears to be claiming that, at the time of the deal, Lawson mis-estimated how much revenue would need to be deferred for the newly acquired Intentia contracts. So, I asked if this were the case.
Debes responded:
To answer your question directly - no we did not think the deferral rate would be as high as it has turned out. We estimated a 40% deferral rate for the former Intentia's products for the first quarter and then improving numbers over the course of the year. For many reasons, our deferral rate has been and average of 50%. Also, the accounting treatment for the acquisition wiped out any previous deferred balance on Intentia's books, so we were starting the year with nothing. By then end of this year, we will have built a balance of $40-50m in deferred revenue and next year we will be able to take that into revenue at the rate of $8-10m per quarter.I decided not to attempt to delve into the reasons that Lawson's deferral rate was different from what Lawson originally estimated. Suffice to say that, according to Debes, there should be an improvement in Lawson's GAAP financial performance in the next fiscal year if for no other reason than the realization of deferred revenue.
My point is that while we are building this backlog, we have artificially low revenue (license revenue) and earnings in our current fiscal year. That should all be behind us next year.
Debes' other main point is that, apart from immediate financial performance, Lawson's business is strong. He claims 35-45 wins over SAP and Oracle every quarter, which he attributes to Lawson's deeper focus on its target markets, such as retail and health care, along with Lawson's "more intimate relationship" with its customers. Over the long term, those are the things that should result ultimately in superior financial performance. It will be interesting to return this time next year to see whether it turns out to be the case, because investors have certainly not rewarded Lawson relative to SAP and Oracle in the past year (see relative share prices for the three companies below).
Lawson still has challenges in integrating its Intentia business and operating as a global company. In its conference call, Debes also pointed out that it is behind in meeting its goal to ramp up its sales force. Add to this the challenge of moving its existing customer base to its new Landmark architecture. For the sake of choice in the marketplace, and to keep things interesting, I hope Lawson is successful.Related posts
Business brightens for Lawson
Lawson acquiring Intentia
Blogging from the Lawson user conference
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