Now that the software industry's dismal earnings season is winding down, Wall Street has given up on its optimistic scenario of a second-half recovery.

Analysts and fund managers are conceding that spending in the sector won't pick up before the fourth quarter at the earliest. It's a conclusion reached even after several software companies such as

Oracle

(ORCL) - Get Report

,

Siebel Systems

(SEBL)

and

Veritas Software

(VRTS) - Get Report

declined to offer guidance beyond the current quarter, saying they just don't have the visibility.

That said, investors shouldn't necessarily write off software completely. There are a few bright spots, including companies that cater to the retail industry.

Allan House, a technology analyst at Pittsburgh-based Federated Investors, describes his current strategy this way: He's underweight software and just trying to avoid problems. Indeed, the software sector has suffered a recent rash of accounting jitters. Among those hit recently with concerns about accounting:

Peregrine Systems

(PRGN)

and

Network Associates

(NET) - Get Report

.

House believes corporations will need at least two profitable quarters before they start spending more on software; one quarter is too easy to dismiss as a mere blip. And initially, spending may be modest because companies bought so much in boom times, only to lay off employees as business soured. So even when companies start hiring again, House noted, they won't necessarily need to buy more PCs or software seat licenses because they'll still have leftovers.

"We could be looking into the first half of the next year for sales to start picking up at the software and hardware companies," House said.

Like others, House is projecting a sequentially flat second quarter for software, a seasonably weak third quarter and sequential growth in the fourth quarter, fueled by year-end purchasing.

Pat Walravens, an analyst at Jolson Merchant Partners, is more pessimistic. "Our view is that software spending in Q2 2002 will be slightly worse than Q1 and that the second half of 2002 will be roughly flat with the first half," Walravens said in a recent note.

Indulging the Optimism Habit

In an interview, Walravens said he believes software firms had less of a backlog of potential deals going into the current quarter than they did in the first quarter, despite comments from executives on conference calls saying their pipeline was larger.

"I think this will be the third or fourth time Wall Street has jumped the gun on when it

tech spending is going to come back," he said.

Indeed, if there's one thing Wall Street can agree on, it's that a full recovery in software will take longer than everybody in the industry initially expected. Previously, the thinking was that if a general recovery comes in the first half of the year, tech stocks would start reaping the benefits in the second half of 2002.

On earnings calls, some CEOs stuck to that view -- sort of. Tom Siebel, for instance, said he "can't believe" IT spending isn't going to pick up in the second half of the year. Still, the Siebel CEO kept guidance for the second quarter relatively vague and declined to forecast past then.

So where's an investor to turn?

There's always the old software stalwart. "Microsoft came out the strongest of them all; they made their numbers," said Pacific Crest Securities analyst Brendan Barnicle, who has a buy rating on the company's stock. After some confusion, analysts said

Microsoft's

(MSFT) - Get Report

operating income came in above guidance, though revenue fell short of Wall Street estimates.

Although the Redmond, Wash., behemoth guided down for the year, Microsoft raised the prospect of improvements in the PC market, Barnicle noted. His firm hasn't done any banking business with Microsoft.

Still, Microsoft shares have lost about 20% of their value since the beginning of the year.

Mercury Interactive

(MERQ)

was another strong performer. The company, which makes software that tests and manages Web-based applications, beat estimates and reiterated full-year guidance. Mercury benefited from companies that bought software last year and now want to test and manage it better this year, said House, whose firm's funds own the stock. Shares of Mercury Interactive have increased just over 9% since the beginning of the year.

Retail Stands Out

Other standouts in the first quarter: software companies that specialize in serving retailers, including

Retek

(RETK)

and

JDA Software Group

(JDAS)

. JDA's top line grew 21% year over year, and pro forma earnings rose 25%.

"The retail sector has historically not spent as much on tech as other verticals have, and now they're starting to upgrade their systems and it's benefiting these guys," said House, whose firm owns JDA shares.

Since the beginning of the year, shares of JDA have increased 30.6%. Shares of Retek, whose first-quarter revenue rose 44.6%, have declined 24.2% since the start of the year.

Clark Chang, a senior equities analyst at Firsthand Capital Management in San Jose, Calif., said that retailers that overexpanded their space in the 1990s are now focused on making their processes more efficient, with the help of software. His firm's mutual funds hold shares of Retek and JDA Software.

Cheaper, but Cheap Enough?

Software stocks generally have not been cheap relative to other tech stocks, Chang said, but that's now changing. The Goldman Sachs Software Index is down 29.1% since the beginning of the year. Chang is predicting a rally in software as more investors take advantage of cheaper prices.

But Walravens, who has hold ratings on all of the five software stocks he covers, is more cautious. While he believes software will be in a good position when the economy recovers, he doesn't want to recommend buying shares now, despite the prices.

Take Oracle, Walravens said. When he initiated coverage with a hold rating in January, its price was $15.94. This week, Oracle set two new 52-week lows, falling into the single digits, last reached in 1999. Shares closed Wednesday down 59 cents, or 5.9%, to $9.45 on news of

another executive departure and worries that the company's fourth-quarter numbers would fall short.

"If it's going to keep dropping, it seems to me you don't tell your customers to buy it," said Walravens, whose firm hasn't done any banking with Oracle.

"I'm not trying to call the bottom," Walravens continued. "I'm just trying to get a sense from enterprises that they're going to spend again."

And he hasn't seen that they're ready yet.