Cracking the Books: Manugistics' Warning Flags (cont'd)

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This is the second part of Whitney Tilson's analysis of the accounting of Manugistics Group. To go to the first part, click here.

Rising Accounts Receivable

In any company, but especially in a high-growth situation, it pays to watch carefully for ballooning accounts receivable, which can often indicate future trouble. Accounts receivable are measured in terms of the number of days' sales outstanding.

Manugistics' Growing Accounts Receivable Accounts receivable as measured by days' sales outstanding, or DSO
Fiscal Quarter	DSO (in # of days)
Q1 1999	103.4 days
Q2 '99	109.5
Q3 '99	120.0
Q4 '99	115.4
Q1 2000	108.9
Q2 00	108.1
Q3 '00	102.2
Q4 '00	80.9
Q1 '01	85.0
Q2 '01	100.8
Source: Company reports, Tilson Funds For example, in the second quarter of fiscal 2001, Manugistics had accounts receivable of $64.2 million and revenue of $58.15 million. (64.2/(58.15 x 4)) x 365 = 100.8.)

We can see that after a remarkable improvement toward the end of fiscal year 2000, DSOs have risen sharply in the past two quarters.

Negative and Declining Free Cash Flow

Revenue (to some extent) and net income (to a large extent) are opinions, but cash is a fact. That's why I spend so much time focusing on a company's cash-flow statements.

The key number I look for here is free cash flow, which I define as cash provided by operating activities, minus capital expenditures, and adjusted for two line items that I don't believe are truly related to operations. These are changes in deferred income taxes and tax benefits that companies receive when employees exercise stock options. Doing these calculations for Manugistics yields free cash flow over the past six quarters of:

Manugistics' Declining Cash Flow As measured by Free Cash Flow*
Fiscal Quarter	Free Cash Flow
Q1 2000	$2.0 million
Q2 '00	($1.3 million)
Q3 '00	($5.0 million)
Q4 '00	$8.6 million
Q1 2001	($8.5 million)
Q2 01	($11.8 million)
Figures in parentheses are negative. Source: Company Reports, Tilson Funds * -- Cash provided by operating activities, minus capital expenditures, and adjusted for changes in deferred income taxes, and the exercise of employee stock options.

Over the past four quarters, Manugistics' free cash flow has been negative $16.7 million (on sales of $188.1 million), significantly worse than net income (adjusted for one-time charges), which was a negative $5.6 million. That's worrisome by itself, but the sharp decline in the most recent two quarters -- driven largely by the big jumps in accounts receivable noted above -- is especially troubling.

Comparison of i2 and Manugistics

Manugistics has shown accelerating growth over the past three quarters, but has yet to generate meaningful profit from this growth and, in fact, on a free cash-flow basis, is losing more money than ever. So why has the stock gone parabolic? (Since it closed at $12.43 on June 21, the day before it reported first-quarter 2000 earnings, it has risen 276% to Monday's close of $46.69. Over the same period, the Nasdaq 100 Unit Trust (QQQ Quote - Cramer on QQQ - Stock Picks) has fallen 35%.)

An analyst quoted in an article last August offers an answer. In it, Bill Gramas, an analyst at Gruntal, said, "You know how Wall Street wants to find a 'me-too' company? This is a story where i2 Technologies (ITWO Quote - Cramer on ITWO - Stock Picks) is the clear leader in the space, and Wall Street is saying there must be someone else in the space that we can pile into that's cheaper. In this case, it was Manugistics."

But Manugistics isn't cheaper, based on a multiple of next year's estimated earnings per share. Let's compare these two companies on a number of dimensions:

Manugistics: Key Metrics
	i2	Manugistics
Stock price (12/18/00)	$49.69	$46.69
Revenues (trailing 12 months or TTM)	$923.7	$188.1
Net income (TTM)	$77.3	($7.1)
Net margin (TTM)	8.4%	(3.8%)
Earnings per share (TTM)*	$0.20	($0.11)
Estimated next year's EPS	$0.34	$0.25
Future P/E	146x	187x
Free cash flow (TTM)**	$69.0	($16.7)
Year-over-year revenue growth (most recent quarter)	118.4%	72.1%
Year-over-year EPS growth (most recent quarter)	106.1%	($0.13) to +$0.03
Projected 5-year EPS growth rate (First Call)	45%	35%
Flow ratio (most recent quarter)***	0.84	1.18
Flow ratio one year ago	0.97	0.94
(All figures in millions unless otherwise noted; figures in parentheses are negative.) * -- Trailing earnings per share are pro forma, as reported by the companies. Future EPS for i2 is FY ending 12/01; for Manugistics, 2/02. ** -- Free cash flow for i2 is estimated, using the same formula described above for Manugistics, but adjusting for a large one-time increase in deferred revenue. *** -- The flow ratio is: (current assets minus cash & cash equivalents) divided by (current liabilities minus short-term debt). It is a measure of balance sheet strength, and a lower number is better.)

i2 is the stronger company on every dimension, and it's trading at a significantly lower multiple of next year's estimated earnings. So does that make i2 a bargain?

Hardly. I think both companies are preposterously overvalued, but based on these numbers, one has to wonder why investors are awarding Manugistics with a higher valuation multiple.

Conclusion

Despite the warning flags I've identified, I don't think Manugistics is engaged in any irregular accounting practices. It's not uncommon for certain metrics on the balance sheet and cash flow statement to weaken or become erratic when a company sees a huge, sudden surge in its growth.

But when a stock is priced for perfection -- and Manugistics certainly is, especially in today's brutal tech market -- the company had better deliver perfection. The items I've identified above make me seriously question whether Manugistics can deliver. We'll know more after the company releases its earnings report after the close Tuesday, and files its 10-Q in a few weeks.

To return to the first part of this story, click here.