Frontstep Still Awaiting Better Times

Event Summary

On August 14, Frontstep, Inc. (Nasdaq: FSTP), a leading provider of business applications for mid-sized distributors and manufacturers, reported its financial results for the fourth quarter and full fiscal year ended June 30, 2001. Total revenue for Q4 2001 was $29.0 million, an increase of 7% sequentially over the revenue of $27.2 million for Q3 2001, but a 6% drop compared to $31.0 million revenue a year ago (See Figure 1). License revenue was $12.6 million, an increase of 18% sequentially over the $10.7 million reported in Q3 2001, but again, it was a 16% drop compared to $15.0 million revenue a year ago.

The Company reported a net profit of $289,000 from normalized operations, which exclude amortization of acquired intangibles and the costs associated with the restructuring that had been announced early in the quarter. For this restructuring, which included the write-off of certain assets, Frontstep posted a charge of $4.5 million in the quarter and the total reported net loss was $5.0 million, which is an improvement compared to Q4 2000, when the Company posted a net loss from normalized operations of $5.8 million and a total net loss of $9.5 million (See Figure 1).

Figure 1.

For the year ended June 30, 2001, total revenue was $118.3 million, an 8% drop compared to $128.9 million for fiscal 2000. License revenue was $52.4 million, a 9.5% drop compared to $57.9 million in 2000. The reported net loss for the current year was $24.8 million, of which, $7.8 million was from normalized operations and the balance of $17.0 million was related to the restructuring and amortization of intangible assets. This compares to a net loss of $10.2 million for fiscal 2000 (See Figure 2).

Figure 2.

During the fourth quarter, Frontstep completed a restructuring effort that reduced operating costs by $28 million or 25%. The Company expects to benefit from the full effects of these cost reductions in the current quarter ending in September. Also, the Company completed a significant new $25 million credit facility with Foothill Capital Corporation, which was previously announced on July 20th. The credit facility includes a $15 million three-year term note and $10 million in revolving credit. This facility replaces a $15 million facility with another bank and significantly improves the Company's borrowing capacity.

Market Impact

It is somewhat perplexing why Frontstep's recovery has been taking that long. The last 18 months have undeniably been the period of radical business model change for the company. The name change was more than mere a name change - it reflected the company's shift of focus from being a leading mid-market ERP vendor to its emphasis on front-office and supply chain applications that help companies connect more intimately with their customers and suppliers.

Frontstep also revised its sales channel, delivery methods, and pricing strategies in order to improve the traction of its entire product portfolio. It has positioned itself to be not only an applications vendor, but also an e-Business strategist and consulting provider. Through its division, the brightwhite services group, Frontstep will provide e-business design and deployment services as required by customers. Having a combined, software and services product mix should allow Frontstep to provide its target market with an e-business strategy and the applications to embody it. Lastly, the company has made attempts to develop an indirect channel to supplement its strong direct sales force in order to better approach the lower-end of its target market.

Having achieved all the above necessary steps, one wonders why the market's response has so far been quite tepid. The apparent economic slump and vigorous competition from Tier 1 vendors should not be the only explanations; although they are valid given the recent malaise of many smaller vendors with the concurrent success of SAP and PeopleSoft supply chain solutions. It appears that the marketing job Frontstep has been undertaking has not struck the right cord with its target audience. The name change to Frontstep will require a more vigorous marketing effort to inform potential and existing clients and the affiliate channel about the 'new old' company and to create strong unified brand awareness. The confusion in the market about multiple brands (Symix vs. Frontstep) must have taken its toll in less enthusiastic customers' response.

Frontstep is still apparently figuring out how to facilitate adoption of e-business by the low-end of manufacturing and distributing industry. Smaller manufacturers and distributors have traditionally been pragmatic rather than early technology adopters. Mid-market companies have increasingly been looking for a single source for their core back office system needs and/or to extend the existing applications to both customers and suppliers, in order to maximize their investment and reduce the complexities of integrating disparate applications.

Frontstep's focus shift to value chain management matches the shift in e-commerce focus from indirect materials procurement to areas such as strategic sourcing, channel management, and supplier enablement. Therefore, while Frontstep seems to have positioned itself well as it already possesses most of the required components, it needs to deliver a much clearer message to the market.

The company needs to simplify its high-sounding 'Digital Supply Chain' (DSC) or 'managing value chain' vision into a plain English worded strategy of helping its business partners buy and sell goods over the Internet, which includes on-line collaboration with customers, suppliers, distributors, and employees, and thereby makes everyone's internal operations more efficient. In a market with stringent IT budgets, Frontstep has to demonstrate how its CRM, ERP, and SCM products deliver actual savings. Enterprises have to see the value of tying their supply chain functionality to their marketing, sales, and service operations, and the point of gathering enough information about what customers need so that actual physical supply chains can evolve into informational demand chains. Moreover, Frontstep has to create stronger awareness of its applications with an architecture that allows smaller companies to support specific processes as needed and to see measurable results in less than 90 days.

We maintain our belief that the company has articulated an e-commerce vision that should have an appeal to its mid-market users. Frontstep is offering its core transaction back-office systems (SyteLine and SyteDistribution), then front-office functional modules purchased from Profit, and supply chain functionality from its much older purchase of Pritsker and DAI. Frontstep is also delivering its Active Link backbone to provide end-users with the ability to connect suppliers and customers to its core transaction system. While Frontstep has been promoting the concept of an integrated solution, including both ERP and e-Business components, the company is also pursuing stand-alone sales of its e-Business offerings in a back-office agnostic manner.

The openness and interconnectivity are one of the most important factors of competitiveness within the enterprise applications market nowadays. The broad scope and flexibility of its recently enhanced product offering, particularly the multi-site capable-to-promise (CTP) functionality of Frontstep APS (advanced planning & scheduling) and order fulfillment, supply chain collaboration and the improved global functionality of SyteLine, as well as the size of the existing customer base should provide Frontstep with recurring revenue and possible profitability during the looming mid-market carnage.

User Recommendations

While Frontstep's current cash situation (~$1.5 million) may raise some eyebrows, potential and current Frontstep users should not be overly anxious about the company's viability. It should be able to maintain the leading position within the mid-market given its latest credit facility arrangement. Frontstep has more than 20 years experience in the mid-size distributors and manufacturers market, with more than 4,000 customers. The company was one of the first mid-market ERP vendors to acquire an APS vendor, and has long supported CRM functions including product configuration.

By investing more than $50 million in R&D since 1998 despite the revenue falloff times, the company has broadened its product lines and responded to recent market trends, and gained a head start over its peers. As the R&D effort seems to be winding down and since Frontstep has aligned its operating structure to more realistic sales targets, it will be crucial now for the company to properly convey an e-business message to the manufacturing and distribution mid-market and to demonstrate benefits to the prospect or customer, in order to increase its currently low traction and return to profitability.

Mid-market discrete make-to-order (MTO) or engineer-to-order (ETO) manufacturing or distribution enterprises and/or divisions of Fortune 1000 corporations with less than $300 million in revenues, which are looking for a vendor that provides both e-business applications and related services may benefit from evaluating Frontstep.

More comprehensive recommendations for both current and potential Frontstep users can be found in Symix Systems Front-Steps Into Greener e-Commerce Pastures.