ClickSoftware's Investment Thesis Remains Intact

On October 11, 2010, ClickSoftware (CKSW) issued a 3Q 9/10 results update (excerpt below) in anticipation of the pending earnings announcement scheduled for October 21, 2010. This resulted in a significant stock action. By the end of the day the stock had dropped over 7% to $6.14/share on a volume nearly six times the 90-day average.

This article discusses the earnings update, the unwarranted drop in the stock price, and the unaltered state of the investment thesis which entails a relatively low business risk and increasing fundamental stock value supported by sustained growth in revenues and in free cash flow. The estimated fundamental value of the stock, based on expected FYE 12/10 results, is $10.27/share (see chart below).

3Q 9/10 Results Update

“Clicksoftware Provides an Update on 2010 Third Quarter Results

Strong Outlook for the Fourth Quarter

BURLINGTON, Massachusetts, October 11, 2010 /PRNewswire via COMTEX/ --

ClickSoftware Technologies Ltd., (NasdaqGS: CKSW), the leading provider of automated workforce management and optimization solutions for the service industry, today announced that it anticipates revenues for the third quarter ended September 30, 2010 to be approximately $17.3 million. The Company also estimates that its cash, cash-equivalents, short and long-term investments increased by approximately $6 million during the third quarter, reaching about $48 million as of September 30, 2010.

"While the timing of specific contracts somewhat impacted our third quarter revenues which are anticipated to be 5% to 6% below plan, our business remains strong and we expect to close the gap with revenues of more than $20 million in the fourth quarter. On an annual basis we expect revenues to be in line with our previously stated guidance. We believe that most of the contracts that have been delayed will be booked in the near term. Our projection for the fourth quarter is based on a concrete list of prospects for which the sales process is in advanced stages, as well as repeat orders to fulfill customers' operational needs that we believe will be placed during that quarter," said Dr. Moshe BenBassat, ClickSoftware's Chairman and CEO. "We continue to see strong demand for our products, engage in new substantial partnerships and further develop our strong pipeline," he added.

These preliminary results are based on ClickSoftware's initial analysis of operating results and are subject to change as additional financial information becomes available. Third Quarter Earnings Release and Conference Call. ClickSoftware will release its third quarter 2010 financial results on Monday, October 25, 2010, during pre-market hours. The Company will host a conference call and live webcast on the same day, at 9:00 a.m. ET. The earnings release will be available on the Company's website at http://www.clicksoftware.com prior to the call. ………….”


Market Overreaction

The drop in the price of the stock seems to have been caused by the anticipated $17.3 million in 3Q 9/10 revenues, representing 5% to 6% below plan (as I recall, this is the first time that such a plan is publicly disclosed). This deficit, the announcement conveys, is due to the timing of certain specific contracts. Apparently it refers to delays incurred in the ordinary course of business pipeline implementation, and not due to any deterioration in market demand, or in the acceptance of the company’s products or services, or in the company’s strategies, structure, or competence.

The company also stated that the business remains strong and reinstated a previously issued annual guidance. On 2Q 6/10 earnings reporting date the company reiterated “previously provided year 2010 guidance of revenues in the approximate range of $71.5 million to $74.5 million, representing about 17% to 22% growth over 2009”.
By the way, the $17.3 million in anticipated 3Q 9/10 revenues represents growth of over 4% y-o-y.

Continued improvement in free cash flow generation was implied by the announced update that cash and marketable securities reached $48.0 million at the end of 3Q 9/10. This is an increase of $5.5 million from $42.50 million at end of 2Q 6/10; substantially larger than the $3.72 million achieved in the previous quarter; from $38.78 in 1Q 3/10 to $42.50 million in 2Q 6/10.

Buttressing continuing strength in revenue growth, the company indicated that revenues in the fourth quarter would grow 16% y-o-y to exceed $20.0 million, a quarterly revenue record.

All in all, the update (revenue delay) does not portray substantive weakness on the part of ClickSoftware. In fact, strength in free cash flow generation and sustained annual revenue growth, support the view that the investment thesis remains intact --- ClickSoftware represents a low business risk with growing revenues and free cash flow that support increasing fundamental value.

Fundamental Value Estimate

Information from the recent announcement and past performance data have been organized in the chart below to present progress in selected value metrics. These support a fundamental stock value of $10.27/share based on $10.0 million of free cash flow estimated for FYE 12/10.

Particularly noteworthy (not shown in the chart) is the acceleration of free cash flow per Dollar of revenue (FCF/Revenues) during the first two quarters in 2010. [FCF is defined as Cash from Operations minus depreciation (fixed asset replacement)]. The ratio of FCF/revenues was 20% in each of the first two quarters in 2010, versus 10%, the average FCF/revenues for FYE12/09.

Coupling a high cash content in revenues with effective use of capital (in net operating working capital and in operating net fixed assets) results in outsized measures of FCF/Operating Capital (and ROIC); 80%+. Apparently the market has not taken due notice.

ClickSoftware ---Selected Value Metrics and Estimated Fundamental Value of the Stock

(Amounts in millions of US$, unless otherwise noted)

FYE 12/07

FYE 12/08

FYE 12/09

FYE12/10 Estimate

Revenues

40.02

52.26

61.12

72.36

Revenue Growth (y-o-y)

23%

31%

17%

18%

EBIT

1.36

6.28

11.14

12.82

EBIT / Revenues

3%

12%

18%

18%

Cash Flow from Operations

4.91

8.54

7.55

12.00

Free Cash Flow

4.29

7.79

6.15

10.00

Free Cash Flow / Revenues

11%

15%

10%

14%

Enterprise Value

289.00

Cash (+)

24.70

32.00

34.97

50.00

Debt (-)

0.00

0.00

0.00

0.00

Equity Value =

339.00

# Shares (:)

28.50

29.50

31.81

33.00

Fundamental Stock Value =

10.27

Stock Price (10/12/10)

6.22

Gain

65%

Free Cash Flow = CF from Operations minus Depreciation (replacement). Enterprise Value = PV of discounted future FCFs

Click to enlarge

Summary

The drop in the stock price following ClickSoftware’s 3Q9/10 earnings and outlook update seems to be unwarranted; the revenue delay is not due to any substantive structural business issue, but only timing. In all likelihood the sales shortfall will actually occur in 4Q12/10; that is why 4Q12/10 revenues are expected to reach record levels.

As shown in the chart above, growth in revenues and in free cash flow continue at a sustained pace. They support a fundamental value of $10.27/share, or 65% gain relative to the stock price on 10/12/10.

In closing, I’d like to recollect a couple of issues that underpin the investment thesis, which remains valid. These were discussed in earlier Seeking Alpha articles, dated 8/18/10 and 9/26/10.

First; the operational risk in ClickSoftware’s business is relatively low due to the stability of revenues supported by the high priority placed on CKSW’s products by clients on their spending budgets, and due to the granular client diversification by size of account and geography.

Financial risk is also low; the company has abundant liquidity due to strong free cash flow generation, substantial cash balances, and zero financial debt.

Second; ClickSofware is front and center in the response to growing complexity in the relations among consumers, business, and government; and to the increasing demand for technology-driven business improvement. Such improvement is a high-priority for firms and other entities who want to be competitive and seek to become value-based organizations. Increasing aggregate product demand for workforce management and optimization solutions will continue to drive ClickSoftware’s growth in revenues and free cash flow.


Author's Disclosure: Long CKSW