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Baan In Dutch

With its fifth CFO in four years and six straight quarters in the red, the ERP vendor is struggling to stay afloat.

1May

The year 2000 dawned with surprisingly benign impact on the computer networks of businesses around the world. But for Baan Co., the world's fifth-largest supplier of enterprise resource planning (ERP) systems, the new millennium is off to a dismal start. On January 4, the Barneveld, Netherlands- and Herndon, Virginia-based software maker announced that it expected to lose $236 million in fourth-quarter 1999--more than half the loss a restructuring charge due to the closing of 14 offices and a 4 percent reduction in the workforce. It was Baan's sixth consecutive quarterly loss, and it virtually wiped out shareholders' equity in the company.


But even all this may not have been the worst news from Barneveld that day. Baan also announced that CEO Mary Coleman--the company's greatest asset, in the eyes of the analyst community--was resigning, just seven months after taking office. With her Silicon Valley roots, Coleman was seen as Baan's best chance to survive in a market being transformed by the Internet. "Coleman was keeping the company afloat," says Rod Johnson, research director at AMR Research Inc., in Boston. "When she left, people got spooked."


And not just investors who drove the stock down 30 percent on the news. One week after Coleman hit the road, CFO James Mooney, whom Coleman had recruited from IBM in March 1999, left the company for greener pastures--namely, the corner office at TradeOut.com, a B2B Web business. (Coleman eventually landed as a managing director of operations at Internet Capital Group, a Wayne, Pennsylvania-based Internet incubator.)


The latest quarterly loss and management exodus (there have been four CEOs and five CFOs in the past four years) suggest that Baan is not yet out of a tailspin that began two years ago. At about $5, its stock is down 90 percent from a peak of $54 in April 1998, and now trades for a dollar less than its initial public offering price five years ago. Meanwhile, Baan's customers, which have automated their mission-critical operations with the vendor's software, have had their confidence badly shaken.


"Our prime concern is to regain the confidence of the financial community and our customers," declares CFO Robert Ruijter, who was hired in February by interim CEO Pierre Everaert. Ruijter previously spent seven years with Royal Philips Electronics NV as group treasurer and later CFO of the company's lighting division. With the giant Dutch manufacturer undergoing a massive restructuring over the past five years, Ruijter has had plenty of experience managing in tough situations. He knows only one thing can restore Baan's battered image: "We need to become profitable soon."


How did one of Europe's most promising tech companies fall so far, so fast?



It Started With Accounting

Begin with the Baan brothers, Jan and Paul, who founded the business as a financial consulting firm in 1978. In the 1980s, Jan, the techie of the two, transformed Baan into a supplier of business management software based on the Unix operating system. With the explosive growth of the Unix platform, Baan too thrived, introducing its first ERP system in 1990, which automated and integrated various back-office operations of manufacturing companies. Baan's European client list grew rapidly.


The company also signed up several high- profile North American customers, such as Boeing Co. and Northern Telecom (now Nortel Networks), in 1994. Between 1993 and 1997, annual revenues grew by an average of more than 80 percent, and the company was emerging as a top competitor to market leader SAP AG in the manufacturing segment of the ERP market. From its IPO price of $5 in May 1995, Baan's stock rose to more than $50 by early 1998. That's when the trouble began.


Specifically, it started with accounting. In 1997, the American Institute of Certified Public Accountants changed the rules for recognizing revenue from the sale of software in its Statement of Position (SOP) 97-2, making it more difficult for companies to book sales up front for products and services to be delivered in the future. All the ERP vendors were affected; SAP, for example, was forced to defer $250 million more in revenues under the new accounting rules than it did when reporting in its native Germany. The three major U.S. vendors, Oracle, PeopleSoft, and J.D. Edwards, were also affected. But no company suffered more from SOP 97-2 than Baan.


In part, that was because of the company's practice of leasing software to companies. The contracts were typically multiyear, and the company would recognize up front the revenue from the expected life of the lease. Baan was forced to defer $43 million of such revenue in the first quarter of 1998, causing net income to drop to $2 million from $13 million.



Confusing Relationships

Even more damaging to Baan's credibility was the spotlight cast on its confusing relationships with distributors and resellers, many of which were private companies owned by the Baan brothers. At the end of 1997, Baan adopted an indirect sales strategy to better address the small-to-midsized corporate market. It started using resellers for those customers, selling directly only to companies with more than $300 million in sales.


To manage the channel, Jan and Paul Baan established Baan Midmarket Solutions, which provided sales support and training for the resellers. The brothers also established a large reseller, Baan Business Systems, on their own. Both companies were controlled by the brothers' holding company, Baan Investments. Although the two had earlier transferred their 39 percent stake in the public company to a charitable foundation, they retained the voting rights of the stock, and the non-arm's-length relationship between the public and private entities put a scare in the market.


Not only was Baan unloading significant sales costs on the private ventures, whose books were closed to public scrutiny, the ventures were also buying large amounts of software from Baan. Of the $113 million in sales to midmarket customers reported in 1997, at least half were to companies owned by the Baan brothers. And given the large amounts of software in inventory at those companies, there was at least the appearance that Baan's phenomenal sales growth may have been helped by stuffing the distribution channel. The lack of transparency was enough to scare off such investors as Putnam Investments, which once owned a 9.4 percent stake in Baan. Putnam unloaded its entire position because of the situation.


In July 1998, Jan Baan stepped down as CEO and left the management board. The brothers also changed the name of their holding company to Vanenburg Ventures in an attempt to distance themselves from the public company. But the damage to the company's credibility was done.



Boom Or Bust

Investors, already uneasy about Baan, panicked when the company issued a profit warning on October 12, 1998. Baan's stock plunged from 18 to 11. A class-action shareholder lawsuit was filed, alleging that the company issued "materially false and misleading financial statements" and employed "fraudulent accounting methods."


The problem was falling demand. Like all the ERP vendors, Baan was a major beneficiary of the impending millennial date change, as thousands of companies chose to replace their legacy software systems with Y2K-compliant ERP systems. But because such systems frequently require lengthy, difficult implementations, most companies bought their new systems by third-quarter 1998, in order to install them by the January 1, 2000, deadline. On cue, new- license revenues for all the ERP vendors plummeted in fourth-quarter 1998, and Baan shifted into survival mode. It sold off 10 service and support subsidiaries, closed or consolidated 50 offices, and cut 20 percent of its workforce in the fourth quarter of 1998. Along with the $200 million restructuring charge, the company also wrote off $56 million of existing inventory in the indirect channel, bringing the total loss for the quarter to $295 million.


As expected, the ERP market remained in the doldrums for most of 1999. Gartner Group Inc., a technology advisory firm in Stamford, Connecticut, estimates that new purchases of ERP licenses dropped by 70 percent last year. Accordingly, Baan's total revenues for 1999 were $635 million, down 14 percent from 1998.


Now that Y2K has passed, will demand for ERP systems pick up? There are some positive signs. Baan's license revenue rose by 92 percent in the fourth quarter, albeit off a small base in 1998 that also reflected inventory write-downs. Other vendors are also landing more orders. Many analysts believe, however, that the ERP market will never return to the heady growth rates of 1997 and the first half of 1998.


The reason is the Internet. While thousands of companies have installed ERP systems to automate back-office functions like accounting, production scheduling, and human resources, they are now venturing onto the Web to pursue E-commerce opportunities. For that, they want Web-enabled software that handles their interactions with customers and suppliers over the Internet. The stars in this market are companies such as Siebel Systems, which sells customer relationship management (CRM) systems; i2, which sells supply-chain management software; and Oracle, which is the acknowledged leader among ERP vendors in developing Internet-based applications.


Baan, too, is scrambling to recast itself as a Web-friendly supplier. Before she left, Mary Coleman shifted Baan's research-and- development budget significantly toward E- commerce technologies, and the company is now marketing several applications to handle procurement, sales, configuration, and fulfillment over the Web.



The Sin Bin

In the wake of Coleman's and Mooney's departures, CEO Everaert and CFO Ruijter have their hands full. They have to fix a battered balance sheet and determine whether Baan has a future as an independent company.


Everaert has publicly stated he is open to offers for the company. And Jan Baan has suggested that Baan is an attractive opportunity for American companies. So far, Lazard Freres, hired in February to investigate alternatives, has come up with nothing.


Everaert and Ruijter's more immediate concern, however, has been raising equity capital. Last year's $289 million loss left Baan with just $9 million in shareholder's equity. And with the company expected to lose money for several more quarters, it is one small step from the "sin bin"--Amsterdam Stock Exchange­listed companies running a shareholder deficit. (Never mind that most of the dot-coms on Nasdaq, where Baan is also listed, would qualify for Amsterdam's sin bin.) Ninety percent of trading volume in Baan shares occurs in Amsterdam, and the Dutch company is determined to avoid the indignity of being dropped from the blue-chip AEX index. "We need to get this nonproductive issue off the table," says Ruijter. "I would rather spend my time on issues our customers are concerned with."


The new management team's first move may be the start of what some analysts think will be the unraveling of Baan's acquisition strategy of the past five years. In March, Everaert sold Coda Financials, an accounting software vendor Baan purchased in May 1998. The $49.3 million that System Software Associates paid for Coda resulted in a $30 million gain for Baan. "Coda buys them another quarter," says Ruurt van der Torre, formerly an analyst with ABN Amro. But just a quarter: "Either they have to raise more money, or they'll have to do more [asset] disposals."


Everaert and Ruijter, who worked together at Philips Electronics, are doing both. In February, they negotiated the conversion of $40 million in convertible debt to stock at a price of $6.25 per share rather than the original $22 price in the bond covenant. They also sold Baan's $40 million stake in Meta4, a European human resources management vendor, which resulted in another $20 million gain.


Still, with the company currently losing money at a rate of more than $25 million per quarter, $90 million won't keep Baan out of the sin bin for long, particularly if the ERP market doesn't pick up dramatically this year. To gain more breathing room, Baan recently cut a deal with Bear Stearns that allows it to sell as much as 150 million euros' worth of common stock to the New York investment house over the next 18 months, at market prices. In return, Bear Stearns gets to immediately buy 1.5 million new shares from Baan for the piddling sum of 90,000 guilders (around $39,000), or about 38 cents per share.



Breaking Up

Still, stronger actions--the selling off of software assets, or even a buyout of the entire company--may be necessary. Analysts say that CAPS Logistics, a decision-optimization software company that Baan bought in the fall of 1998, is a likely candidate for sale. Others suggest that Baan may have to part with its crown jewel, Aurum Software, the CRM firm that Mary Coleman ran before Baan bought it in 1997. Aurum is growing far faster than Baan's core ERP business, and by itself is worth more than the whole of Baan, says AMR's Johnson.


In an attempt to avoid an outright sale of Aurum, Baan announced on March 29 that it will set the company up as a separate subsidiary and seek investment from venture capitalists. Eventually, Aurum could be spun off as a separate company with its own listing--not on the Amsterdam exchange. Given that analysts estimate the company is worth close to $1 billion, the remaining stake in Aurum would help shore up Baan's dwindling equity position.


In the meantime, Everaert and Ruijter have to decide what to do with the rest of Baan's assets. Unlike SAP, which developed its suite of ERP applications in house, Baan filled out its product line by buying companies. In 1996, the company acquired Berclain and Antalys, which produce manufacturing scheduling and pricing management applications. The following year, Aurum and Beologic provided sales force automation technology, and in 1998 Coda Financials and CAPS Logistics rounded out one of the broadest range of offerings in the industry. "Baan had great vision in technology and products," says van der Torre.


The problem, as any CIO can attest, is that independently developed software applications are difficult to integrate with one another. Furthermore, most of the acquired companies maintained their own sales and marketing organizations, and Baan has had little success selling new products to their client bases. "Baan became a holding company rather than a synergized ERP company," says Byron Miller, vice president of Giga Information Group. "Information transfer [between the companies] was at a minimum, and most of the pieces have floundered."


The result being that Ruijter may have to overhaul Baan's far-flung organization and possibly take further restructuring charges down the road. "In many ways, I find Baan more complex with 5,000 people than Philips was with 50,000 people," admits Ruijter. "There are a lot of confused responsibilities in the company. We need to organize our processes and establish business controls."


Ironically, the company finally launched its first fully integrated enterprise application suite, Baan V, at the end of last year, and is now testing it with clients. What's more, several of Baan's Web-based offerings, notably a collaboration software tool, are getting good reviews from customers.


"The sad thing is the products have never been healthier," says AMR's Johnson. The question is, will Ruijter and a new CEO have the chance to market them?



Likely Suitors

A buyout from a company like Microsoft or IBM would go a long way to repairing Baan's tarnished brand name. Both companies have been mentioned as possible suitors, but most analysts say that's wishful thinking. Microsoft and IBM make money collaborating with all the ERP vendors, and they are not likely to risk upsetting competitors by aligning themselves with one company--no matter how cheap it is.


The other ERP vendors are also unlikely buyers. Given the lack of synergies between separately designed software systems as complex as ERP, Baan would have to be operated as a stand-alone entity. Perhaps the most logical buyer would be one of the CRM or E- commerce companies whose market caps now dwarf Baan's. With an installed base of about 5,000 companies, Baan would offer significant access to new customers for, say, a Siebel Systems or i2. And if it could perfect the integration of its applications, a combined CRM/ERP company could offer a true end-to-end enterprise solution.


A nice idea. But with the company expected to lose another 9 cents per share in the March quarter, Everaert and Ruijter can put such strategic visions out of their minds. Until they demonstrate that Baan is financially viable, they aren't likely to find any interested buyers. Instead, the management team will have to focus on cutting costs and paring down the company to a profitable size. "Baan recruited me because I'm not high- tech," says Ruijter. "I'm a down-to-earth manager, and that may be what Baan needs most at this point." Certainly customers hope so.



NERVOUS CUSTOMERS

Investors weren't the only ones who were dismayed by the sudden management exodus at Baan Co. last January. The software company's customers were just as shocked by the news.


Michael May, vice president of information technology at Teknion Furniture Systems Ltd., a Toronto-based furniture maker, was already anxious about the string of losses and bad press Baan had suffered over the past two years. And like many industry analysts, May saw former CEO Mary Coleman as a savior for the troubled software supplier. "She had a clear vision of where the company needed to go," says May, who has been implementing Baan ERP applications at $630 million Teknion since 1993. "If I were chairman [of Baan], I would have written a check for whatever it took to keep her."


Alas, Coleman is gone, and so is ex-CFO James Mooney. And corporate IT managers like May, who rely on the support and continued product innovation of Baan for their mission-critical business applications, face the unsettling prospect that Baan may never recover its financial footing.


The products aren't the problem. May is perfectly happy with the performance of his ERP system, and is currently in the midst of deploying Baan's Web-based applications for processing customer orders and collaborating with vendors. Likewise Boeing Co., Baan's largest and most important customer, announced in March that it would upgrade 19 work sites with Baan V, the company's latest integrated ERP suite. "We're pleased with our product, and we're not looking to change vendors," says Boeing spokesman Bob Jorgensen. Boeing was a flagship North American customer when it chose Baan as its ERP supplier in 1994. The aerospace giant is about 60 percent through its implementation of the software, which will ultimately be installed in 27 major sites in commercial aircraft plants, with up to 20,000 employees using the system.


"One of our biggest customers continues to have confidence in us," says Baan CFO Robert Ruijter. "They're upgrading because they see further advantage to it." Analysts also surmise that Boeing may have gotten a sweet deal from Baan on the upgrade. Regardless, the vote of confidence suggests that if Ruijter can stabilize Baan financially, the company can sell new Web-based products and ERP upgrades to existing users.


Indeed, the company's customer base of approximately 6,000 is its most valuable asset. Maintenance and service contracts with those customers currently account for about 60 percent of Baan's revenues. They are also the most likely buyers of new products. If customers start defecting to other vendors, Baan's days as a going concern are numbered.


Keeping the existing customer base happy is one thing. But attracting new customers will be a far more difficult task for Baan. If the company continues to lose money, it's only a matter of time before service and support levels deteriorate. And without profits, the company's research-and-development budget will also soon suffer. Either prospect is enough to scare away potential new buyers. "Implementing ERP systems is a 10-to-15-year relationship," says AMR Research analyst Rod Johnson. "If you're worried that a software supplier is going to be dismantled, there is reason to be cautious."

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