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Growth Companies Feel
Pressure to Book Sales
By GREG IP
Staff Reporter of THE WALL STREET JOURNAL
It's nail-biting time again in growth-stock country.
As another quarter draws toward an end, officials at technology and
other high-flying companies are getting anxious about meeting sales
targets, while savvy customers are turning up the pressure for
discounts. Both sides know that if just a few sales fail to close by the
quarter's end, a company may fall short of hitting analysts' earnings
estimates. That, in turn, could trigger a big plunge in the company's
stock price.
"Customers know that the vendor needs to get the deal done by the end of
the quarter to satisfy Street expectations, and they use that as a
powerful negotiating tool," says James Smith, a portfolio manager at
Pilgrim Baxter & Associates. "'OK, you want our $2 million order and you
want to ship it by the end of June? Fine, we can make that happen for
you, but this is what it will take: an additional 15% discount, or
better shipping terms.' Customers have become very, very sophisticated
in how to use their leverage because of the financial markets."
All that makes the closing weeks of a financial quarter more stressful
than usual for growth companies -- those with higher-than-average
expected earnings growth -- particularly smaller companies, for which
each order is critical, and for the analysts who follow them. Often,
more than 50% and as much as 75% of such companies' sales comes in the
last month of the quarter, producing a "hockey stick" sales pattern.
Management may not know until late whether it will meet Wall Street
estimates. That contributes to the burst of negative profit warnings and
stock carnage around a quarter's end.
"The joke in Silicon Valley for years has been, the chief financial
officer calls the shipping dock at noon on the last day of the quarter
and says, 'How did we do?' and the answer is, 'I don't know, the quarter
is only half over,'" relates Thomas Thornhill, director of technology
research at Montgomery Securities Inc.
"It produces stress for everybody," adds John Rossi, a technology
analyst at Robertson Stephens & Co. "Late snafus, shortage of
components, or sudden wavering by a customer could have a huge impact on
the quarterly results. Suddenly out of nowhere comes this surprise
shortfall, and that's when you get the mind-spinning drops in stock
prices."
Technology companies are especially vulnerable to last-minute pressure
tactics by customers because they are so closely followed by Wall
Street.
"We encourage our clients to wait as long in the quarter" as possible to
make a purchase, says Jim Seay, research director at the Gartner Group,
which advises major purchasers of technology. "Companies who don't make
their earnings forecast are punished terribly, so that pressure flows
down through the entire chain of command on the vendor side. The deal
window opens the first or second week of the third month of the
quarter."
The problem is most acute for companies with a relatively small number
of customers, such as IKOS Systems Inc., Cupertino, Calif., which makes
expensive simulation systems for electronics manufacturers; its 10
largest customers typically account for more than half the sales in a
quarter.
"You have to spend a lot of time with each individual account, and you
miss a couple of those, and it gets pretty ugly in a hurry," says IKOS's
chief financial officer, Joseph Rockom. "We had a couple we thought we
could get [in the second quarter] and they slipped out," though he
blames customer-specific issues rather than negotiating tactics. That
played a part in IKOS warning in early July that revenue would be less
than expected, sending its stock down $5.25, or 26%, to $15.125 in one
day.
The customer, he adds, "knows these high-tech companies are all trying
to make their quarter and all of them are kind of on the hairy edge, so
if [the supplier] needs another order to make his quarter, he's going to
be a lot more receptive to negotiations." He says that though Ikos
doesn't discount heavily, "if we need [the sale] to make the quarter,
we'll do what we need to get it."
Mr. Rockom notes the customer faces pressure to close as well because it
knows the leverage is gone once the quarter is over and the supplier is
back in the driver's seat.
The late-quarter pressure is more often implicit than explicit, and
originates on both sides, analysts say. Keith Mullins, a stock
strategist at Smith Barney Inc., says, "I've seen cases where the
companies have [said] to customers, 'We need to make a quarter, take
some extra product.'"
Avid Technology Inc., a Tewksbury, Mass., developer of computer editing
systems for broadcast, movies and video, failed to complete some
expected sales in the last quarter of 1995. It warned in late December
that year it would undershoot analysts' estimates, sending the stock
down $10.625, or 36%, to $19 in one day.
Ned Hazen, Avid's senior vice president of business development and
corporate treasurer, said the firm last year decided it would kick the
late-quarter discounting habit. It began to shift from direct sales to
distributing more through resellers, adopted standardized discounts and
reduced or eliminated end-of-quarter discounts and promotions. It took
several quarters to convince customers it was serious, he said. "There's
a high degree of cynicism among customers: 'Yeah I hear you saying it,
but let's see how you react at the 13th week of the quarter.'"
While Avid did fail to meet some of its revenue targets as it put its
new policies in place, the impact on the already-languishing stock price
was minimal. But thanks in part to reduced discounts, Avid was able to
boost margins this year, beat first-hand second-quarter estimates and
see its stock soar to $34 from below $10 earlier this year.
Still, Gartner Group's Mr. Seay says it is rare for any company to
continuously resist the pressure for discounts, because customers have
become so skilled at extracting them.
And the arm-twisting has spread beyond discounts. Pilgrim Baxter's Mr.
Smith says on occasion a company being acquired suddenly delays closing
the deal near the end of the quarter. That gives the target company
extra negotiating leverage because the acquirer is expected to meet
estimates based on the combined companies' earnings, he says.
Analysts have learned to spot the symptoms of a company dangerously
addicted to discounting. "More backloading, more discounting, increases
in accounts receivable, days outstanding, finally the company reaches
the breaking point and it has to disappoint," says Mr. Rossi at
Robertson Stephens.
One analyst says he has tried to spot hard-disk-drive makers in the act
by calling up distributors late in the quarter, posing as a customer, to
see "if they would make sure not to let a sale get away on the phone.
Sometimes, I'd find prices would drop sharply over a one-week period.
You'd say, 'What if I bought 10?' Suddenly you'd get a sweet price -- a
20% drop."
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