Jenny Ruth: Cash flows for Software of Excellence

Software of Excellence (SOE) is at last delivering on its promise after nearly five years as a listed company and seems to have overcome its early propensity to fail to meet its forecasts, but you wouldn't guess that from the share price.

The dental software company's shares were floated in December 2000 at $1 apiece and roared away to $3.60 in early 2002 before getting trashed as other high-tech stocks collapsed, dropping as low as 75 cents in the first half of 2003. They recovered to $2.15 in early 2004 but have been on a downward spiral since and were trading yesterday at $1.16.

And yet the company has been cash-flow positive for the past two years and reported a $204,215 net profit for the year ended March 31, beating its previous forecast. That compared with a $750,106 net loss the previous year.

The latest result was after $1.12 million in amortisation and $545,889 in depreciation. SOE's interest bill nearly doubled to $889,000 due to its $9.235 million convertible note rights issue and placement in September 2004.

However, $4.6 million of notes issued in 2002 are due to convert to ordinary shares in December which will reduce its interest costs.

The company had forecast it would be profitable this year at the September 2004 annual meeting.

Then this February it said the result was likely to range from a loss of $250,000 to a profit of $150,000, which depended on a number of factors including the New Zealand dollar's strength and one-off costs relating to the July 2004 $4.1 million acquisition of General System Design (GSD) in the US.

Britain accounted for 75 per cent of the company's sales in the latest year and the New Zealand dollar cross rate to the British pound had devalued by about 12 per cent so far this year, said chairman Jim Syme at last month's annual general meeting.

He dangled the hope of the company passing another milestone, starting to pay dividends, in front of shareholders at that meeting.

The board was "conscious that many shareholders in New Zealand do invest for dividends" and it will review the dividend policy early next year, he said.

The company could have chosen to become profitable earlier if it hadn't chosen to continue to invest in its overseas markets, mainly the US and Britain.

But its success in selling software to high street dental practices in Britain has been spectacular. It is now out-selling its major competitor by two to one.

Chief executive Brian Weatherly, who took over the job from his brother Paul a little over a year ago, suggests the company isn't likely to slip back into a loss-making position.

"We certainly feel that we're moving into profitability and that's the direction we want to keep moving into."

Weatherly notes that five years ago, there were 30 players in its market in Britain but now it's a duopoly. While the other player, Kodak currently has a greater share of the high street dental practices market, SOE is rapidly closing the gap at the rate of about 20 sites a month, he said.

Back in 2002, the opposition had about 1000 more sites and now it is about 650 ahead.

Now that SOE is more secure in that market, it no longer offers customised software to those dentists, selling only completely off-the-shelf products.

At the annual meeting, Weatherly said the company needed to be cautious about over-promising, especially the larger contracts the company is chasing.

"We've realised it's much more about service project management, training, customised software development. You've got to be quite pragmatic to make that business succeed."

The company is waiting on the British Ministry of Defence to make a decision on who will supply it with health software.

That decision continues to be deferred, the ministry missing yet another deadline in August.

However, a decision will be made eventually and SOE is in the happy position of being a subcontractor to both contenders, IBM and Logica.

Weatherly says that although the company is in a strong position, there are no guarantees and it is possible a competitor could undercut it on price.

"We may risk losing the [Ministry of Defence] business because we were too pragmatic rather than making commitments that we will struggle to meet afterwards."

Every contract like the defence one must be profitable in its own right.

"A number of companies in software have struggled [to deliver]. We're careful not to go there."

One criticism that could be levelled at the company is that it's sitting on too much cash. In March 31, it had $9.2 million in cash. Of last year's capital raising, $3.75 million was earmarked to buy GSD in the US.

The rest of the money was to have been spent on other acquisitions. Weatherly says there are many possibilities on the table and that he doesn't particularly want that money to keep sitting on term deposit.

The GSD purchase bought the company both access to a greater number of customers as it supplied software to 16 US dental schools compared to SOE's three, and to greater expertise in that market.

"The US is probably the most parochial culture in the world. They see themselves as the greatest nation on earth and that gives them an inwards looking view."

A company from a small country like New Zealand selling software to the US is regarded rather like we would regard somebody from Fiji trying to sell us a high-tech product, Weatherly says.

"You basically want to appear American with an offshore element."

So far, four of GSD's dental school customers have agreed to adopt SOE software and two others have opted for a competitors product.

"With any acquisition, there's a risk of customers being unsettled. The customers aren't all perfectly happy the day you step in. We do accept that."

After consuming huge quantities of cash in previous years, the US operations are now cashflow neutral, although they're still contributing negatively to net profit.

The four GSD schools signed are now contributing to SOE's recurring revenue, the building of which has been one of the company's major focuses.

In the latest year, recurring revenue accounted for 44.2 per cent of the $20.8 million in total sales.

The company has undergone significant management upheavals in the past year.

Weatherly is the only one of the company's four founders still in an executive role although his brother Paul and Errol Kent still sit on the board. Kent, 61, and partner Clare, who were responsible for developing the company's British presence. Paul Weatherly still works for the company on a contract basis.

Weatherly says in the early days, the four had worked in a collegiate fashion but had come to the realisation that the company needed a more traditional chief executive structure with operational issues sorted out at the management team level rather than being debated by the board.

Weatherly attributes the flagging share price to a combination of the stock's lack of liquidity and a lack of interest from the institutions.

Also, he says the share price is mostly news driven and that as the company grows, it's getting harder to make material announcements.

Several developments that would previously have been announced separately are likely to be announced together with the company's first-half results later this year.

Software of Excellence Headquarters: 106 Bush Road, Albany, Auckland

Profile: the company provides dental software to high street dental practices and to large institutions such as dental schools and public health authorities.

Market capitalisation: $26.2 million.

Latest results: The company reported a net profit of $204,215 for the year ended March 31, compared with a $750,106 net loss the previous year.

Management: managing director Brian Weatherly, chief financial officer Bryce Donnell.

Major shareholders: Co-Investor with 10.96 per cent, Clare and Errol Kent with 10.64 per cent, Paul and Elizabeth Weatherly with 6.13 per cent and Brian and Kay Weatherly with 4.07 per cent.