ClickSoftware gets it… somewhatPosted: July 25, 2013
As it is the case for all postings in this blog, my standard disclaimers apply for this posting. However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice. Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.
Giving it to us straight
ClickSoftware Technologies, an Israel based enterprise software company that I have written quite a lot about (for a baseline discussion, go here,) is a market leader in the supply of scheduling software for enterprises.
Recently, in an unprecedented move, the company had altered its annual guidance, announcing that it anticipated revenues for 2013 to grow substantially less than indicated in previous guidance and, also, that it anticipated that it would incur losses in its second quarter, primarily as a result of an increased activity in Software as a Service (SaaS) business.
In a posting that I wrote on July 20th, 2013, about this alteration of guidance and the impact of SaaS on the revenue line for enterprise software company (read it here) I noted that the change of guidance was not unexpected (although it, of course, was unfortunate) given the company’s entry into the SaaS licensing market, which has a completely different revenue and cost profile than the on-premise licensing. Moreover, I noted that the issue of cannibalization is significant, potentially causing delays in deal closing and significant increases in operational costs.
Significantly, it appears that the company was unprepared for the uptake in SaaS business, being essentially forced to resetting the guidance. If this is case, it would be very disappointing, indicating that the company has problem maintaining its competence as it grows.
The market’s reaction to the company’s announcement was immediate and extreme, sinking the per share price for CKSW, the company’s equity, from $8.50 to $7. However in a period of 14 days, or so, between the date of the announcement and today’s release of the quarterly earnings results, the per share price recovered much grow, growing to $7.70.
The company’s earnings conference call was what is perhaps best characterized as vintage BenBassat, performed using the Cool Hand Luke approach of the company’s CEO, Dr. Moshe BenBassat, with facts being provided and no apologies offered.
This approach was not generally embraced by the market and the per share price of CKSW dropped 5% on unusually high volume.
Dr. BenBassat gets it… somewhat
What I noted about the call was that Dr. BenBassat, in his capacity of co-CEO, essentially discussed the same challenges that I had outlined in my earlier posting: Selling enterprise class SaaS solutions is essentially equivalent to financing your customers, with the SaaS provider incurring high up-front expenses and substantially less revenues in the hope that the customers’ user counts will grow over time and, eventually, provide a high level of profitability.
In my posting I wrote:
Selling enterprise class SaaS solutions is essentially equivalent to financing your customers, with the SaaS provider incurring high up-front expenses and minuscule revenues in the hope that the customers’ user counts will grow over time and, eventually, provide a high level of profitability — something that TOA Technologies knows very well, because they are already caught up in the spinning tops mechanics of SaaS.
In the conference call Dr. BenBassat said:
I guess when we look into the statistics of what we have in the pipeline for the second half of the year, it looks like we have a larger number of deals relative to last year but each one of them is relatively smaller amount of licenses. So we probably have what we need to generate similar levels or higher of license revenues, and perhaps it’s even lower risk because if one of them disappears, it’s not as bad as it was when you depended on one large deal.
So, Dr. BenBassat, and, by extension, the company, gets the issue with revenues, which is encouraging for an investor. The second part of his comment, implying that there is less risk to the pipeline could be correct, but it is amply offset by the risks added by 1) having to maintain a larger, lower quality sales-force to capture lower quality deals, and 2) the closing, financing, and operational risks inherent with lower quality deals
Reffering to the reset of the guidance for fiscal year 2013 I wrote:
Essentially, the release of two alternative pricing models by a company for an offering creates a situation where the company in developing its guidance need to discriminate between the two offerings, and, since the company has no historic data providing a basis for such discrimination, it is forced to choose the lowest possible guidance.
In the conference call Dr. BenBassat said:
… [Let’s] take an example that in the past a perpetual license deal of $1 million. If it was relatively simple to implement, then you get an order for $1 million and you recognize right away, and you have additional $1 million licenses in this quarter. On the other hand, if this customer decides to go on a cloud software-as-a-service monthly fee of, let’s say, $50,000 a month, that after 2.5 or 3 years will roughly be about the same $1 million we just spoke about, then in this quarter you only have $50K and of course it’s very minimal.
But let’s now move forward, let’s say, three or four months ago. At any given year, say 2013, let’s say that you finish December 31, 2013 with $1 million in services, software as a service cloud licensees. On January 1 of 2014, this is still there, okay, and now every new account that you add will be added to this $1 million monthly recurring revenues. In the past, whatever you signed, you signed, and now you have to start working hard to sign another $1 million deal and another $1 million deal. That’s why, as I say, in the long term it’s certainly a very, very favorable development and it will slow down the growth rate, not necessarily the growth, the growth rate of the company; but in the future, it will contribute to stability, more predictability, and so forth. So that’s the explanation.
Again, Dr. BenBassat gets it. However, he ignores the important fact that customers may terminate their relationship with the company (voluntarily, in a situation where the customer takes advantages of the fact that there is a lower barrier to replacement by the sold system by a competitor of ClickSoftware Technologies or (somewhat) involuntarily in the event of a change is business structure of business direction.)
Moreover, Dr. BenBassat logic is flawed, because revenues attributable to a customer in an on-premise license deal does not, in fact, terminate when the deployment is complete. Rather, after deployment, support and maintenance, which carries revenues with extremely high margins, kick in. Furthermore, if you have an on-premise license arrangement there is a degree of customer intimacy that is non-existent in the SaaS universe and almost always leads to a continuous stream of upgrade and customization revenues and, importantly, increases the “stickiness” of your deployment, acting as an additional competitive barrier.
Actually, I am being unfair. At this stage, Dr. BenBassat, who clearly is highly intelligent, probably gets the full picture (although I suspect that the ClickSoftware Technologies team, including Dr. BenBassat was caught with their pants down on these issues and have mostly been in frantic regrouping mode since the beginning of the fiscal year,) but, as the CEO of a publicly traded company, probably feels compelled to spin the facts.
The fact that there is spin became evident when, in the Q&A part of the conference call, direct, pointed questioned were deflected:
Question: Okay, and just a last piece to this – do you have sort of a ballpark estimate of where you expect to settle in terms of percentage of recurring revenue three years out?
Dr. BenBassat: Yeah, let’s not go into this at this point in time.
Picking through the spin, I believe that the real story behind the company’s problematic second quarter and potentially problematic year comes down to a few simple facts:
- The company was under-prepared for the increase in interest in the SaaS model, but over-prepared on the infrastructure side, akin to a military force that build up an arsenal of main battle tanks in anticipation of large scale, Kursk-like, tank battles, but encounters disparate attacks by partisans using improvised explosive devices in an ambush pattern.
As Mr. Shmuel Arvatz, the company’s CFO, let slip on the conference call, the company’s structure is simply not prepared for the way that SaaS business is structured:
Moshe referred mostly to the revenue side and the fact that you move to subscription rather than to one-time. On the expenses side, the operation is built to support much higher revenues in terms of the operations and investments. So this creates also pressure on the gross margin because we did not achieve any economies of scale in the model right now, but the model is built for much higher revenues.
- The actual number of SaaS deals secured in the quarter was very low, and, therefore, the company is still not clear on what the mechanics will be of a SaaS deployment. Moreover, therefore, the revenue shortfall in the quarter was not attributable to a change in order composition, but, rather, to self-inflicted delays in the prospect’s selection process, i.e. to cannibalization.
As Dr. BenBassat acknowledged during the call:
Yeah, we don’t report this number, but quite frankly, as I said, the revenues – not necessarily the number of customers, the revenues – from cloud revenues is still relatively marginal compared to the 24.7 million that we had in the quarter.
It’s just, as I say, some slippage, some argumentation whether it’s going to be internally within the customers on the prospect side whether this deal is going to be a perpetual license deal or a cloud deal, and this sometimes delays deals….
The real issue here for is, therefore, not the fact that the market shifted, but, rather, the fundamental question of whether or not the company has lots its competency edge as it has grown. As I wrote in an earlier posting:
I, for one, would be severely disappointed to learn that, by engaging in the pursuit of SaaS opportunities, ClickSoftware Technologies has entered into uncharted waters where it no longer can control its destiny with the same degree of certainty that it could just a year ago.
If these events are in any way related to a lack of competency, then the ClickSoftware technologies leadership team need to take a hard look at its culture
Unfortunately, yes, in spite of some impressive tap-dancing by Dr. BenBassat on the conference call, it does appear that the company has, indeed, lost some competency and has entered into uncharted waters. Moreover, it has entered into these waters on its own volition and now is paying the price.
So, there we have it…. The no apologies conference call has substantially revealed that the company, undoubtedly somewhat aided by a shift in the overall software market, has put itself in a situation where it has less control over its future than it had last year and may be incurring a substantial expense increase and revenue slowdown in the short to medium time-frame.
The hope, of course, is that this expense increase and revenue slowdown will be offset by increased and more sustainable and predictable revenues with higher margin in the future, but, for now, this hope is unsubstantiated and all the investors see is margin and revenue erosion. Naturally, in the quick-buck, short-term outlook market of today such margin and revenue erosion is a punishable offense, and, therefore, CKSW is currently being punished.
The irony, of course, is that it does not matter, since, at the most fundamental level of investment, nothing has really changed. In fact, with the no apologies approach applied in the conference call, Dr. BenBassat and the company has simply confirmed what long term followers of ClickSoftware Technologies have known for years: An investment in ClickSoftware Technologies is a long term play and the company will punish anyone who engages in short-term speculation around the company’s equity. As I wrote in February of 2013:
I would have thought that traders would have sought other pastures, simply viewing CKSW as too volatile and too unpredictable, particularly since it has a management team that may or may not meet traders’ and the market’s expectations — and probably won’t lose any sleep over these expectations, but, contrary to my expectations, the traders appear to still be around shorting, longing, and optioning CKSW as much as ever. Go figure.
In a nutshell, from the perspective of an individual or institution that has a long-term outlook on ClickSoftware there is almost nothing wrong with the company and its equity. The company’s operation management success is nearly unparalleled, and historically the company has managed to strike a good balance between investment in future opportunities and consistent delivery of strong results. However, once you commit, you better strap in and hang on tight, for there is no knowing where the company’s management team and Board of Directors are going to take you.
I would be remiss if I did not touch upon the big elephant in the room. On top of the potential for long term growth, the company offers the promise of the Big Kahuna in the form of an acquisition by Oracle or SAP. However, from an short- to medium-term investment standpoint, chasing such event is folly, since, although it has been the subject of intense discussion in investor circles since the time of the company’s IPO in 2000, there has, so far, been absolutely no indications from the company’s management team or Board of Directors that it was even being considered.
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