Agilent Faults Software Project for Corporate Loss

Agilent Technologies is blaming a botched software deployment for recent poor financial performance. But analysts and investors aren't buying.

No one, inside or outside companies, is rooting for information system projects to go awry. But what's infuriating to investors and the Wall Street analysts, brokers and other professionals who make their living discerning fact from fiction in financial reports, is the recognition that no one—including the top officers at the companies in question—is proving whether the explanation is valid or a diversion.

"This looks like just another example of a company shifting blame for Wall Street's sake," says Gartner Inc. analyst Brian Zrimsek. "But I think after what we've seen in the past couple of years, people are getting smarter. At some point these companies need to start looking at themselves."

Here's what we do know in this case: In November, Agilent Technologies put the finishing touches on the worst fiscal year in the company's brief history as a standalone entity. The maker of electronic test and measurement equipment posted a net loss of $1.03 billion on sales of $6.01 billion. That followed a net profit a year earlier of $174 million, on sales that were 28% greater, at $8.4 billion.

Yet some analysts, such as Robert W. Baird International's Richard Eastman, hailed Agilent's fourth-quarter sales of $1.74 billion as an "upside surprise" and a step toward returning to profitability.

As Eastman put it in his research report, the results were "stronger than expected, impressive considering the widespread concerns about a possible earnings miss."

That's because Agilent executives told analysts to expect sales just north of $1.6 billion during its conference call following the meltdown that occurred in the third quarter.

Agilent still posted a net loss of $236 million in the quarter, including a $92 million noncash goodwill and amortization charge and a $256 million restructuring charge. Excluding those charges, it lost $2 million, or breakeven on a per-share basis. Analysts projected Agilent would come in somewhere between a loss of 12 cents a share and breakeven.

Agilent shares shot up $3, or 22%, to $16.60 on volume of more than 13.2 million shares. But that "upside" surprise traces back to complications from Agilent's newly installed Oracle 11i E-Business suite, which resulted in a backlog of orders that it was finally able to close in the fourth quarter. The same amount of orders was filled over the six-month span, but Agilent was unable to complete the sales in the third quarter, which ended July 31, and reported them in the fourth.

In its third quarter, Agilent posted a wider-than-expected net loss of $143 million, or 31 cents a share, on lower-than-expected sales of $1.39 billion. Consensus estimates pegged Agilent for a loss of between 10 cents and 20 cents a share in the quarter on sales of between $1.5 and $1.6 billion.

CEO Ned Barnholt says sales fell short by $105 million and operating profit was depressed $70 million by the fallout from the Oracle rollout. The project, which covered 50% of the company's production and material procurement processes, and virtually all of its financial processes, went live June 12 after almost two years of planning and preparation.

Agilent says that had the software project come off without a hitch, it would have posted a loss of roughly 22 cents a share, or nine cents better.

Agilent At A Loss

The goal was to take the more than 2,200 internally developed and highly customized applications running on Unix and Windows NT operating systems—inherited when it was spun off from Hewlett-Packard—and whittle them down to roughly 20 applications that could be transferred to Oracle's Enterprise Resource Planning (ERP) system.

Agilent's "phased approach" to this migration meant that sites in Malaysia, Singapore and the U.S. that provide silicon wafers, molding compounds, resin and other "direct" materials—as well as plants in Canada, Australia, Hong Kong, Malaysia and the U.S. that provide indirect materials such as chemicals and consumables—went live under the system in June. Deployment of the system to final manufacturing plants around the globe would be completed within 18 months.

During this switchover, Agilent says roughly 6,000 orders in the internally developed systems had to be converted to the Oracle format. Because of complications during the configuration process (which officials at the former Hewlett-Packard division refused to comment on), about one week's worth of normal production was lost. This, Agilent says, resulted in the sales and earnings shortfall for the third quarter.

"The disruptions associated with that new system have been more extensive than we expected," Barnholt said in a statement about Agilent's third-quarter earnings. "The good news is that, at this point, we believe the [planning system] implementation is stable, and we are confident we can meet anticipated customer requirements."

Enterprise software experts and Wall Street analysts expressed skepticism about both the explanation for the integration snafu as well as the material impact these problems may or may not have had on Agilent's financial performance.

"It's not just the complexity of the project," Agilent spokeswoman Karen Lewis says. "It's also the history here at Agilent and HP. Each of our business units developed its own applications over many, many years. We're talking about thousands and thousands of applications."

Industry and Wall Street analysts say the way Agilent ambushed analysts with the sales shortfall and "technology-related" explanation reminded them of similar claims made by other companies in years past.

In July 2001, Nike cited i2 Technologies' supply-chain software as the primary reason it missed analysts' estimates in the third quarter of that year. Hershey Foods claimed that complications from its implementation of SAP's enterprise software shortly before Halloween in 1999 cost the company around $150 million in sales.

"You're always skeptical about this kind of thing," says a veteran Agilent analyst at a large brokerage firm in San Francisco, who spoke on the condition of anonymity. "Every company wants to find an excuse for poor performance and the best way to do that is to find someone or something else to blame. Blaming a software installation is one of the best scapegoats because it's short-term and self-correcting. But those sales and orders that were supposedly lost during this technology change don't just disappear into the ether."

However, Agilent did manage to exceed its own sales estimates by roughly $140 million in the fourth quarter. Was this a product of improved sales conditions? Or were those "improved" sales mainly the result of orders that actually were booked in the third quarter but not closed because of the software glitch?

Gerald Fleming, who tracks Agilent for Fahnestock & Co., says he's willing to give Agilent the benefit of the doubt because he's seen and heard so many other stories of ordering and inventory mishaps that seem to always accompany large-scale software implementations. In its third quarter, printer maker Lexmark, for instance, took a $15.8 million charge for abandoning a project that involved Oracle software for tracking sales and customer accounts.

In the Agilent case, "I guess we have to take it on face [value] that this was a period of transition and a major negative that's unlikely to be repeated," Fleming says. "But I can tell you that no one expected them to lose a week's worth of sales because of this."

It's the lost production and the sales shortfall that industry analysts find most curious.

"Here's the thing I don't understand," says Gartner's Zrimsek. "Let's say Agilent experienced a disruption to its IT architecture today, maybe a terrorist incident that blew up their data center. Would that prevent them from taking orders? No, because they'd have a disaster recovery plan. And if they didn't have a disaster recovery plan, there are bigger I.T. issues at work here than trying to resolve an ERP implementation they had almost two years to prepare for."

Agilent CIO Marty Chuck declined to comment.

"Marty is the guy who would know the most about this but for now all we can say about the project is what we've said previously in public and in our releases," Agilent's Lewis says. "All I can say is, everything is running smoothly now. It was a very complicated project to take all these legacy systems that have been around for years and configure them for this new software. It's kind of like a crazy quilt."

Oracle, which served as the lead integrator for the project, is keeping largely mum, as well.

"We generally don't find it to be a good idea to comment on specific customer implementations as there's the chance that what we say won't match what they're saying," Oracle spokesman Sean Mills said in a statement to Baseline. "We really don't want to point fingers at our customers."

Now, Where To Point?

Analysts say they suspect the reason Agilent's ERP rollout went sour was most likely a combination of insufficient testing, the company's extremely detailed and customized products, and management's inability to properly train its employees to execute what amounts to a complete transformation of the company's business processes.

It didn't help that Agilent's roots as the electronic test and measurement manufacturing division within Hewlett-Packard dates back to the company's inception in 1939. It makes data generators, multimeters and oscilloscopes, as well as semiconductors, optoelectronic components and RF chip sets—all very complex products that require a great deal of customization for individual customers.

Agilent's Lewis says there's no way to overstate the cultural issues involved in taking so many disparate applications created over seven decades at Hewlett-Packard—the poster child for the decentralized organizational structure of Silicon Valley's past—and boil them down to less than two dozen applications.

"It appears that project management was really the big problem there," says Laurie Orlov, an analyst at Forrester Research in Cambridge, Mass. "They obviously didn't do adequate testing and cut over all the transactions at once. If you have hasty and insufficient preparation, rolling back and recovering could take a week." Agilent began planning and preparing for this project in September 2000.

"That's plenty of time for an organization of Agilent's size to easily and effectively complete this implementation," Gartner's Zrimsek says. "Shame on Agilent, a technology company, if they couldn't get their act together in that amount of time for something like this."

To investors, this software implementation debacle is merely the latest symptom of larger problems at Agilent.

Agilent is in the midst of a major restructuring plan that includes laying off 8,000 employees, or roughly 18% of its work force, and the shuttering of several manufacturing plants. It hopes to save $1.2 billion in annualized costs in order to stem the flow of red ink and regain investor confidence. The stock was trading above $150 a share in early 2000 before tumbling to an all-time low of $10.50 a share in October.

"It was not evident from the conference call what was going on in October," Timothy Anderson, an Agilent analyst at Salomon Smith Barney, wrote in a research report. "What's going on here? Is management sandbagging or are business conditions not quite what the October numbers imply?''

Agilent Base Case

Headquarters: 395 Page Mill Road, Palo Alto, CA 94306

Phone: (650) 752-5000

Business: Manufactures electronic test and measurement equipment and semiconductors

Chief Information Officer: Marty Chuck

Financials in 2002: $6.01 billion in sales; net loss of $1.03 billion

Challenge: Install companywide enterprise planning software

BASELINE GOALS:

Reduce inventory of raw materials from six weeks to two days Tally inventory and report financial data on daily basis, rather than twice each quarter Streamline order placement, processing and fulfillment processes

Copyright © 2004 Ziff Davis Media Inc. All Rights Reserved. Originally appearing in Baseline.