Report Card - Ex market darling grits its teeth

By David McEwen

Friday 23rd August 2002

Investors can be fickle creatures and many companies find the task of communicating with them frustrating.

On the other hand, many companies make life hard for themselves by communicating poorly. One awful but common mistake is to overpromise and underdeliver.

The worst culprits are companies that come to the market with prospectuses promising boundless growth. Most don't deliver and are punished for it. Those that beat their forecasts find their share prices highly sought after.

Dental systems company Software of Excellence has managed to both excite and disappoint investors in its two years as a listed company.

Last year it was a market darling. Listed in December 2000 at a dollar, it finished 2001 at well over $3 a share. Even the panic of September 11 and its aftermath couldn't do more than put a temporary dip in its ascent.

Investors had reacted well to its profit announcement and subsequent annual report that year, which showed sales 9% above its prospectus forecast and a matching reduction of its forecast net loss for the year to March 31. Many of those clamouring for its shares last December no doubt assumed that one year of out performance could only be followed by another.

They were wrong.

This year, the company's shares have moved from $3.38 at the beginning of January to below $2.

The cause was a substantial underperformance of its prospectus forecast a loss of $191,000 against a forecast profit of $2.4 million. To its credit, the company moved swiftly to alert the market when it realised its forecast was not going to be met, putting out a statement in January.

Chairman Jim Syme cites the timing of some large contracts, low sales in Australia and Singapore and a decision to accelerate expansion into the North American market as factors.

He remains positive, however, telling investors "that the organisation is on track to an extremely exciting future." Probably sensibly, he isn't any more specific.

Chief executive Paul Weatherly's report gives a succinct rundown on each of the company's territories and is refreshingly candid in discussing where underperformance has been achieved as well as the usual high notes.

He also shows how he is reacting to circumstances by switching the company's focus from its packaged "professional" software product aimed at small surgeries to its tailored "enterprise" solutions for larger organisations.

"The Enterprise Division offers the opportunity for significant future growth and we believe that the risks associated with achieving this growth are lower than those associated with moves to establish new geographical markets for our Professional software," he says.

Despite the disappointing performance of last year, there are a few positive signs.

Turnover rose 40% to $13.7 million and this is matched by a gain in operating cashflows to $12.5 million. That means it is making real money rather than juggling numbers.

However, its costs have expanded to match, with net operating cashflow at negative $487,000, building on 2001's $1.8 million outflow.

The company is financially strong, with virtually no debt and an equity-to-total-funds ratio of 67%. This is prudent considering the company's high-growth nature and volatility in earnings that seem to come with the territory.

Although Software of Excellence's annual report still looks and feels like that of a small company, it is taking its plans for world domination seriously, focusing on elements that normally only attract the attention of much larger entities.

It specifies governance, board practice and reporting systems as well as developing its strategic plan and the work of the board's audit and remuneration committees.

As Mr Weatherly concludes, "We have many opportunities open to us and we face the ongoing challenge of creating a great international business that has the vitality, skills and resources to take advantage of these openings."

With such a game plan there are bound to be more setbacks to come as well as triumphs. Shareholders will have to learn to live with volatility, and give up on kneejerk reactions at every profit announcement.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. Web: www.mcewen.co.nz, Email: davidm@mcewen.co.nz

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