I thought July 4 was when the fireworks went off, but I was wrong. They started on July 6, just after the long weekend was over. Within a relatively short time last Tuesday, Ascential Software, Conexant Systems, Entrust, JDA Software, Kana Software, Micromuse, Netopia, Secure Computing, and Veritas Software all warned of a shortfall in revenue, earnings, or both.

That covers software for enterprise data integration (Ascential), enterprise management (Micromuse), information management and analytics (JDA), enterprise customer-relationship management (Kana), and customer interaction and collaboration (Netopia); products for enterprise data protection and backup (Veritas) and enterprise security (Entrust and Secure); and broadband and wireless equipment and semiconductors (Conexant). That's a broad spectrum of technology and leaves few areas unscathed. The question for investors is whether these financial surprises are company specific or a symptom of a bigger problem.

In most cases, these companies share similar traits: They're smaller than their main competitors, and they're heavily dependent on making their enterprise license sales by the end of the third month of the quarter. As most IT managers know, whenever a technology company has to make a sale by the end of the quarter, negotiating power shifts to the other side of the table. Typically, buyers are reluctant to separate themselves from their cash without a lot of concessions.

Enterprise-software companies that sell large license deals are the hardest to forecast. One deferred deal may set them back on projected revenue by a substantial amount in any quarter. Given the short-term mind-set of investors these days, a revenue or earnings shortfall is disastrous to shareholders of the company. These companies should focus more on annualized instead of quarterly numbers. Otherwise, I believe they can expect to continue to see 20% to 40% share-price declines every time they disappoint the market.

Another trait these smaller companies share is that they seem to be suffering disproportionately. I believe that most businesses are favoring larger vendors over smaller ones. Most potential customers are looking at the financial long-term viability of their providers before signing on the dotted contract line.

Another interesting tidbit is how recent governance changes that strengthened the wall between analysts and investment bankers at most sell-side firms have reinforced analysts' ability to slap an "underperform" or, heaven forbid, "sell" rating on a stock. This would have been almost unheard of a few years ago as most institutional investors always knew that the "neutral" or "hold" rating really meant "sell." After all, it's hard to get investment banking business from companies that are being downgraded by the company's stock analysts. Now, even J.P. Morgan, one of Wall Street's largest investment banks, is getting into the act as it recently downgraded Business Objects, a leading business-intelligence software vendor. I expect that this trend will continue.

Yes, the fireworks started late for the technology sector this quarter, and it's possible the show may last longer than we like.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at [email protected]. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.

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