ClickSoftware 1Q14 Results: Reaffirmation Of A Value Opportunity

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 |  About: ClickSoftware Technologies Ltd. (CKSW)
by: Gino Verza

Summary

Execution in 1Q14 continues appropriately focused on rapid revenue growth and free cash flow acceleration, given high return-on-investment capacity.

Acceleration of revenue deferral due to rapidly growing cloud sales, and increase in expenses to expand R&D and sales capacity, create a double whammy squeeze on GAAP earnings, short term.

The earnings call portrays sustained all-around progress and confidence going forward; management increases 2014 guidance.

Sustained investment to enable growth is sensible and necessary, despite short term GAAP loss. Management value focus augurs well for intrinsic investors.

Value Context

The focal point in this analysis are 1Q14 results within the context of the fundamental value of ClickSoftware Technologies (NASDAQ:CKSW). Value is created by using investors' capital to generate future cash flows at rates of return (ROIC) in excess of the cost of investors' capital (WACC), and by sustaining revenue growth over time. Below are principal value metrics.

  • ROIC (Return on Invested Capital) = NOPAT / OC
  • NOPAT (Net Operating Profit after Taxes) = EBIT (1 - Tax Rate)
  • OC (Operating Capital) = NOWC (Net Operating Working Capital) + OLTA (Operating Long-Term Assets)
  • WACC (Weighted Average Cost of Capital)
  • EVA (Economic Value Added) = (ROIC - WACC) OC
  • FCF (Free Cash Flow) = NOPAT - (Changes in OC)
  • EV (Enterprise Value) = Present Value of prospective FCF, growing at g; discounted by WACC
  • IR (Investment Rate) = Increase in OC / NOPAT
  • g (Growth) = IR x ROIC

This article focuses in 1Q14 results; a more comprehensive coverage of ClickSoftware is available in previous articles in Seeking Alpha.

ClickSoftware Metrics

Table 1 shows selected metrics for ClickSoftware for the last four years; and last quarter's results and y-o-y comparison.

Table 1. ClickSoftware Value Metrics
(Amounts in millions of US$, unless otherwise noted) FYE 12/10 FYE 12/11 FYE 12/12 FYE 12/13 4-Yr. Avg. 1Q 2013 1Q 2014
Revenues 71.02 87.09 100.05 103.18 90.34 24.54 28.38
Growth in Revenue 5% 23% 15% 3% 11% 16%
Deferred Revenues 9.74 11.35 10.55 18.06 12.43 15.53 22.69
Growth in Deferred Revenues 5% 17% -7% 71% 21% 46%
Revenues + Deferred Rev 80.76 98.44 110.60 121.24 102.76 40.07 51.07
Growth in (Rev. + Def. Rev.) 15% 22% 12% 10% 15% 27%
R&D+Selling & Mkt'g Expense 27.13 32.40 45.13 55.68 40.09 12.17 15.61
Growth in (R&D+Sell&Mkt'gExp) 19% 19% 39% 23% 25% 28%
Backlog 15.76 18.65 22.81 24.64 20.47 17.55 24.61
Backlog / Revenues 22% 21% 23% 24% 23% 87%
NOPAT 9.00 12.18 7.12 -5.92 5.60 0.00 -1.85
NOPAT / Revenues 13% 14% 7% -6% 7% 0% -7%
OC 6.57 10.71 8.02 3.80 7.28 5.55 10.62
OC / Revenues 9% 12% 8% 4% 8% 6% 9%
ROIC = NOPAT / OC 137% 114% 89% -156% 46% 0% -70%
EVA = (ROIC - WACC) OC 8.34 11.11 6.32 -6.30 4.87 -0.14 -2.12
FCF (NOPAT - Inc. in OC) 13.36 8.04 9.81 -3.27 6.99 5.67 -6.92
FCF / Revenues 19% 9% 10% -3% 9% 6% -6%
Click to enlarge
  • Four year average ROIC is 46%, well in excess of 10% to 12%, estimated cost of capital . Using investors' capital, costing 12%, to generate FCF that generate 46% creates value (EVA formula, above). Under these circumstances revenue growth is a necessary strategy; both high ROIC and FCF growth are complementary conditions in value creation. The notion of durable ROIC capacity is supported by favorable industry structure (Michael Porter's five forces: entry barriers, substitution threat, buyer power, supplier power, and rivalry determinants), and by the firm's competitiveness.
  • New cloud clients grew from 9 (26% of total new clients) in 2012 to 24 (44%) in 2013. In 1Q14 there were 10 new cloud clients (53%). Deferred revenues grew 71% in 2013 and 46% in 1Q14, y-o-y. GAAP revenue comparisons are negatively impacted by the recent emergence of cloud sales relative to the traditional in-house, enterprise sales. Relative to one-another, cloud revenues spread over longer time horizons, increase deferred revenues, and smooth out prospective revenue recognition.
  • 1Q14 "Revenues + Deferred Revenues" y-o-y growth is a whopping 27%, much higher than 15%, four-year average. This measure eliminates the distortion in the comparison of revenue growth between (NYSE:A) a period of rising/high revenue deferrals (3% revenue growth in 2013) and (NYSE:B) a period of low revenue deferral (15% revenue growth in 2012). The pessimism evidenced by the drop in stock price due to slowdown in GAAP revenue growth in recent reporting periods (3% in 2013 vs. 15% in 2012) is not justified by this analysis.
  • The sustained high growth in "R&D + Selling & Marketing Expenses" feed product competitiveness and selling capacity, both drivers in revenue growth. Growth in 1Q14 "R&D + Selling & Marketing Expenses", y-o-y, is 28%.
  • The increase in absolute dollars in OC in 1Q14, y-o-y, reflects principally the acquisition of Xora, a California-based provider of software-as-service products for small and middle market companies dependent on mobile workforce proficiency. Services are distributed via leading wireless carriers in North America. The acquisition makes sense strategically. It extends ClickSoftware coverage into the small-middle market and opens distribution channels through wireless carriers. Financially, the $12.7 million price paid seems very attractive relative to some $20.0 million in annual revenues (attributed to Xora by un-identified sources; not provided by ClickSoftware). The acquisition was paid from surplus cash.

Earnings Call

Consistency among strategy, execution, financial results, is the hallmark of the 1Q2014 earnings call; competitive wins, industry leadership, market opportunity, rationale for the recent acquisition, and expanded 2014 guidance. Below are highlights and commentary.

  • 2014 full year guidance is raised to $126.0 million to $132.0 million in response to the Xora acquisition and 1Q14 results. Implicit (not provided by management) in $129.0 million, mid-point guidance, is $103.2 million (2013 revenues) + $5.8 million (5.6% increase) + $20.0 million (2014 revenues attributed to Xora; speculative figure). Mid-point guidance would seem conservative if the $20.0 million revenue figure attributed to Xora is in the ballpark; and $132.0 million upper-range guidance would appear quite attainable. Management called for improvement in profit margins in the second half of 2014.
  • Strategies and initiatives in response to new technologies over recent years are now converging to match market demand and industry trends. The functionality of ClickSoftware's software is designed to work in harmony with leading platforms and infrastructures (IBM, Salesforce, SAP); and are device agnostic to run on iOS, Apple (NASDAQ:AAPL), Android, Google (NASDAQ:GOOG), Windows 8, Microsoft (NASDAQ:MSFT).
  • Investment in global expansion (including Xora acquisition) and product development which continue is expected to accelerate growth in 2014 and beyond.
  • ClickSoftware's products and apps cover the end-to-end needs of a wide range of firms, with as few as five employees to as many as 50,000 employees. Apps can be purchased alone as point solutions, or in bundles for bigger needs, or even larger transformation projects.
  • Market demand continues to shift to cloud solutions from enterprise solutions, which continue strong with repeated purchases of licenses; two in the quarter in excess of $1 million each.
  • Contribution from an expanding partners' ecosystem continuous to exhibit strength, including SAP (NYSE:SAP), IBM (NYSE:IBM), Accenture (NYSE:ACN), and particularly Salesforce (NYSE:CRM).
  • Increased revenue stability and reduction in business risk underlie some $60 million in the annual run-rate of recurring revenues estimated by the end of 2014 as follows: $26 million to $30 million from cloud revenues, $39 million from support contracts for on-premise clients. A diversified source of revenues contribute to low risk: 53% of quarterly revenues are from the Americas, 39% EMEA, 8% Asia-Pacific.
  • Liquidity remains high - cash is $50.0 million, after paying $12.7 million for the Xora acquisition. Debt is minimal (probably owed by Xora and consolidated into ClickSoftware statements). Short term backlog and deferred revenues is $47.3 million.

Fundamental Value

Below are two estimates of the stock's fundamental value along with the corresponding estimate inputs.

  • $10.70/share value based on $12.0 million 2014 FCF growing at 15% per annum through 2017 and 5% thereafter in perpetuity. WACC is 10% throughout. On May 2, 2014, the stock closed at $9.27/share.
  • 10.20/share value based on $11.0 million 2014 FCF growing at 15% per annum in 2015, 12% through 2017 and 4.5% thereafter in perpetuity. WACC is 10% through 2017 and 9% thereafter.
  • 2014 FCF input ($12.0 million, $11.0 million) represents 8% to 9% of $132.0 million, 2014 revenues (FCF/Revenues). This is consistent with 9%, 4-yr. Average in Table 1.
  • WACC estimate takes into account the related reduction in business risk, previously discussed, which continues going forward. By way of reference, WACC (equal to the cost of equity, since debt is nil) is computed at 10.0% based on the Capital Asset Pricing Model, as follows [10.0% = 2.58% risk free rate + (8.00%, expected market return - 2.58%, risk free rate) x 1.38 beta]. Beta is influenced (increased) by the volatility in the price of the stock due to short term traders' activity, discussed below.

Summary

ClickSoftware continues to execute well in all fronts. Management's words are consistent with actions and with financial results.

Strategies and initiatives put in place in recent years in the development a software layer that relates to prevailing infrastructure and available devices have now converted into products that are adaptable to varying client specifications and converge nicely with current technologies and market demand.

Expanded Cloud clients and continued investment in resources to expand product proficiency (R&D) and sales capacity (sales and marketing) are welcomed events from a ROIC and value perspective. GAAP accounting of these events brings about a net loss.

GAAP losses are not directly relevant to value but influence the expectations of stock traders who seek profits based on short term stock price movement. Traders thrive on volatility; their actions contribute to sharp changes in the price of the stock over days or months. Conversely, intrinsic investors' expectations are based on long-term value fundamentals beyond days or months. Ultimately, they drive the price of the stock.

The acquisition of Xora appears sensible, strategically and financially. It contributes to ClickSoftware further distancing from competition in terms of market clout and collaboration opportunity in areas such as product, selling and marketing, and distribution.

All in all, 1Q14 results reaffirm a value opportunity. The market price of the stock is below fundamental value. The best is yet to come.

Disclosure: I am long CKSW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The material presented here is for informational purposes only. Nothing in this article should be taken as a solicitation or recommendation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion. Views and opinions in this article may be wrong. The analysis, including financial computations, presentation, and views, do not necessarily conform to any sanctioned or accepted standard. Presentation and computations entail a probability of error, which is entirely possible. I am not an investment management professional. Please do not rely on this material, do your own due diligence.