This week, software company

PeopleSoft

(PSFT)

did the unthinkable. In the midst of a bleak economic outlook, while competitors such as

Oracle

(ORCL) - Get Report

and

SAP

(SAP) - Get Report

have been guiding Wall Street's expectations lower, PeopleSoft said it was on track for its fourth quarter.

Thing is, at PeopleSoft, that has become par for the course. Not only has the company been immune to the warning sickness -- or worse, the misses -- that has infected its competitors, it has been able to stick by the earnings guidance it issued more than a year ago.

Numbers for PeopleSoft have either remained in line or have actually gone higher. If it can achieve earnings of 16 cents this quarter, as it indicated at the Credit Suisse First Boston Technology Conference this week, it will come out of 2001 unscathed. Yet at the same time, issues surrounding a subsidiary and a drop in the company's deferred revenue have prompted some investors to question the quality of PeopleSoft's numbers.

The stock is essentially where it was at the beginning of the year, but it is up 105% since its Oct. 1 closing low of $17.67. Thursday, the stock closed up 78 cents, or 2.2%, at $36.49.

Moving at Internet Speed

So, what's in PeopleSoft's secret sauce? One ingredient has been a full overhaul of the company's software to make it accessible from any computer with an Internet connection, without having to load it on that computer. Because the software doesn't need to be installed on each user's PC, it's easier -- and cheaper -- to maintain. PeopleSoft started selling that flavor of its product a year ago. By contrast,

Siebel

(SEBL)

just started shipping its own upgraded, Internet-ready software last week.

"They've spent a significant amount of time upgrading to an Internet architecture over the past three years, and that's been met positively by customers," says Tom Berquist, an analyst at Goldman Sachs, which has PeopleSoft on its recommended list, its highest rating. "And the new product came at a time when the economy was slowing, which caused more companies to focus on lowering costs. That was aligned with PeopleSoft having the Internet architecture, which helps reduce costs." (Goldman has done underwriting for PeopleSoft.)

Of course, like any rise on Wall Street, PeopleSoft's story has to be considered in context. After all, as recently as 1998, many considered the company to be on the brink of disaster as sales slowed and competition got fiercer. That was before current CEO Craig Conway arrived at the company, and before the product upgrade, which has kept sales going at a time when they've stalled for other firms.

"Part of the question with PeopleSoft is how much they're making up for lost time," says Bob Austrian, an analyst at Banc of America Securities who has a market performer rating on PeopleSoft. "Siebel, for instance, had a phenomenal 1999 and 2000, and is now running at two-thirds of its peak. PeopleSoft had a lousy 1999 and began firing on all cylinders in late 2000, so you get the idea." (His firm hasn't done underwriting for the company.)

Though PeopleSoft's products have gotten good reviews from customers initially, Austrian says, the fascination with Internet-enabled software will eventually wane, and that could affect PeopleSoft.

Counting on the Big Mo

And of course, the company's relationship with its

Momentum Business Applications

(MMTM) - Get Report

subsidiary has raised questions in some investors' minds.

PeopleSoft launched Momentum as a wholly owned research and development subsidiary in 1998, and seeded it with $250 million.

Under that arrangement, Momentum pays PeopleSoft to do research for it. PeopleSoft then licenses the resulting products from Momentum and sells them under the PeopleSoft name. To keep the relationship at arm's length, PeopleSoft pays Momentum a small royalty fee on the products it sells.

That arrangement has sheltered PeopleSoft from some of the high cost of developing software products at a time when other firms have had to invest heavily in that area.

"We needed to completely rearchitect the 108 products we had, and come out with about 60 new products to take advantage of the Web and drive revenue growth in the future," said David Sankaran, PeopleSoft's head of investor relations. "The problem was with the R&D cost and hiring all the people necessary to do that, it would have put the company in the red."

Analysts say Momentum-type arrangements are common in industries with high R&D costs, such as the pharmaceutical sector. But because it's not practiced widely in software -- and because it has protected PeopleSoft's bottom-line as others have struggled -- skeptics abound.

Nathan Schneiderman, an analyst with Wedbush Morgan Securities, says that had PeopleSoft incurred all research and development costs itself in 2000, it would have earned only 8 cents a share for the year, instead of the 30 cents it reported. He wonders what will happen when PeopleSoft phases out Momentum, as it is expected to do in the first half of 2002.

"The company is going to have to pay for a lot of R&D that it's not paying for right now," Schneiderman says. "Our notion is that PeopleSoft will become more challenged, and that the company will need more general acceleration in the economy to achieve its results."

PeopleSoft, however, says that's flawed logic, because it would not have spent as much on R&D if it didn't have Momentum. "I do argue with the premise," Sankaran says. "It assumes we would have built all those 60 products and put the company in a loss. But our board said no, you can't do that. There's no doubt in my mind that

without Momentum, we would have missed the market opportunity for those products."

Dissecting the Revenue Numbers

Because Momentum actually contributes to PeopleSoft's revenue, Schneiderman says PeopleSoft will have to make up for that lost revenue just to stay on a flat growth curve.

Sankaran says the company has already pared those revenues -- from a high of $36 million at its peak to $23 million in the third quarter of this year to an anticipated $15 million during the current quarter.

"We do get revenue from

Momentum, but the revenue from the products we've been able to develop through it should kick in more than enough to make up for it," Sankaran says. "The products we're selling are generating far more than $10 million to $15 million of product revenues. That's why this has been a pretty good tool for us over time."

Aside from the Momentum issue, there also have been questions about a drop in the company's deferred revenue. Software companies often collect revenue upfront for services on contracts they carry out over time and put the money in the deferred-revenue column until services are rendered. On a 12-month contract, for instance, a company would recognize one-twelfth of that upfront payment each month.

Usually, deferred revenue grows in line with actual revenue. But while PeopleSoft's overall revenue has grown from $375 million in the first quarter of 2000 to $509 million during this year's third quarter, the company's deferred revenues have decreased from $524 million to $502 million during the same period.

That causes Schneiderman to worry that PeopleSoft has been dipping into its deferred revenues to build up its top line. That, in combination with the points raised above, is the real secret behind PeopleSoft's success, he says. "The Momentum relationship and the deferred revenue have allowed PeopleSoft to maneuver through this difficult environment where companies like Siebel, that have a much bigger deal focus and higher deferred revenues, have had a much tougher time."

Sankaran says that's not so. What happened, he says, is that PeopleSoft, under Conway's leadership, has gotten much stricter with the terms it offers customers. So, instead of selling a customer a product, it's now requiring customers to pay within 30 or 60 days, and then it recognizes that money immediately on the top line, and this has helped with its revenue growth.

In fact, because of those tighter policies, Sankaran says only $17 million of the company's $502 million in deferred revenue is still derived from direct software sales. The remaining $485 million comes from software maintenance fees, one of the most lucrative forms of revenue in the software business. Sankaran says deferred revenue will begin to rise again as more maintenance fees are added and fewer deferred software sales need to come out of the column.

Sankaran acknowledges that investors have had questions about the two issues and that he's had to explain the company's numbers numerous times. "There's clearly a lot of noise level around this," he says. But from his view, PeopleSoft's real secret is that its sales force has executed well with more, good products to offer at a time the market wants them, and with vigilant attention to which deals will close and which ones won't during trying economic times.

If PeopleSoft can meet its goals this quarter, it will have done its job just fine in 2001.