A Closer Look At E2open's First Earnings Report

Oct.16.12 | About: E2open (EOPN)

E2open Inc (NASDAQ:EOPN) is having a great week after filing its first quarterly earnings report. Analysts weren't expecting a profit from the cloud-based software solutions startup, but earnings seasons are all about surprises. When I saw this NASDAQ infant post positive numbers in its first quarterly filing, I just had to take a closer look to find out if it is as promising as it seems.

If you're not familiar with E2open, it is a leading provider of cloud-based, on-demand software that makes sourcing, manufacturing, selling, and distributing products around the globe more efficient. The company's customers include several divisions of General Electric (NYSE:GE), Celestica (NYSE:CLS), Cisco (NASDAQ:CSCO), Dell (NASDAQ:DELL), Hitachi, IBM (NYSE:IBM), LSI Corp. (NYSE:LSI), Motorola Solutions (NYSE:MSI), Seagate (NASDAQ:STX), and Vodafone (NASDAQ:VOD). The company went public on July 26, 2012 at an initial public offering price of $15 per share. It sank to $11.75 in August and is now just over $17 per share on news of an impressive first month as a publicly traded company.

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The first thing on my checklist is the company's working capital. This is simply the amount of money E2open would have left over if it converted all its short-term resources to cash and used it to pay off its short-term liabilities. E2open can boast a working capital of just under $22 million. That should be more than enough to see it through to next quarter without the need to take on debt to cover day-to-day operations.

E2open is experiencing an extremely small amount of financial strain for a young company. It has a current ratio 1.33. Since it does not need to maintain an inventory or purchase heavy machinery, this amount of current assets to current liabilities is in the Goldilocks zone. Provided its subscribers continue paying their bills on time, it shouldn't have any issues paying its own.

At first glance, E2open appears to be hoarding cash for a company that has no physical inventory or heavy machinery. The company's ratio of working capital to second quarter sales is 96%. Hopefully, it is saving that cash to make acquisitions, or keeping it on hand to buy back shares should its officers exercise their stock options. It is also important to keep in mind that this company's IPO was in July of 2012.

As far as I can tell, E2open has no debt. In August 2012, it paid in full all of its outstanding borrowings. It does, however, have a large amount of liabilities compared to stockholder equity. Its debt to equity ratio of 2.34 is high enough to be a red flag; 73% of its total liabilities is made up of deferred revenue. This is where we go from simple arithmetic to artistry when evaluating a company's balance sheets.

The deferred revenue on E2open's balance sheet is due to the company's long-term contracts. At the end of Q2 2012, E2open was contractually obligated to provide $34.1 million worth (about 73% of total liabilities) of services. This is encouraging for two reasons. First, the cost of providing those services should be significantly lower than $34.1 million, since it is not delivering a physical product. Second, tech companies sometimes try to include deferred revenue on their income statements instead of on the balance sheet as a sneaky way of inflating revenues.

A first glance, E2open's income statement shows an impressive gross margin of 75.27% for Q2 2012 compared to 68.4% for the same period one year ago. E2open's operating margin was also up to 20.82% for Q2 2012 from 14.07% in Q2 2011. Its net profit margin was up to 19.95% in Q2 2012 from 13.03% in Q2 2011. There has been steady progress among both major streams of revenue, professional services and subscription services, over last year - which is a great sign to say the least.

One concern here is that while overall operating expenses rose slower than revenues, the amount spent on research and development was nearly flat. Sales and marketing expenses rose 53% from $4.3 million to $6.6 million. General and administrative costs rose 70.31% from $1.3 million to $2.3 million. Research and development rose only 5.58% from $3.4 million to $3.6 million.

E2open is doing well and operating efficiently right out of the gates. A big concern for me right now are the discrepancies in earnings per share reported. Diluted earnings per share was $0.19 based on 24.4 million weighted-average shares outstanding. The company's 10-Q states net income attributable to common shareholders of $4.566 million and 13.875 million shares outstanding. That is a non-diluted $0.33 per share.

E2open management is honest to a fault. During the latest earnings call, CEO Mark Woodward related its performance by stating non-GAAP earnings much lower than those on its 10-Q filing. The reason is an amended contract with Research In Motion (RIMM). It received $4.5 million up front from the embattled Blackberry manufacturer and was required to include that complete sum as income. E2open contracts typically last three years - perhaps it doesn't expect RIM to be around that long.

Overall, E2open had a great first quarter and the future looks bright. Last fiscal year, the company signed 13 new customers. In the first half of fiscal year 2013, it has already signed 11. For the full fiscal year 2013, the company expects revenue growth of 26%-28% or 21%-22% excluding the RIM amendment. It is on firm financial footing and should be able to continue expanding without diluting shares or taking on excessive debt.

I don't necessarily think the company is overvalued at $17 per share, but I would like to get in at a price much closer to its IPO of $15. Unfortunately, for E2open and luckily for us investors, there is a lot of time between the outset of administrative costs and the collection of subscription fees. For the next two quarters, E2open is forecasting net losses that should help its stock price come back down to earth and give me my entry point.

Data sourced from SEC filings and the company's earnings call transcript.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.