Q1 2012 Earnings Report
- Revenues grew 13% year-over-year to $21.8 million
- Gross Profit grew 6% y-o-y to $12.4 million (margins decreased from 61% to 57%)
- Operating Income declined to $0.49 from $2.81 million, y-o-y
- Net Income declined to $0.7 million ($0.02/share) from $2.2 million ($0.07/share), y-o-y
- 2012 revenue guidance was reiterated in the range of $100.0 million to $105.0 million, or 17% increase y-o-y (management is very conservative and has a good track record in meeting and exceeding guidance).
How does the Q1 earnings report change the investment thesis or the fundamental value of the stock ($13.00/share) discussed in the most recent Seeking Alpha article?
In my opinion the earnings report does not detract from the investment thesis or the fundamental value of the stock. The report focuses on GAAP figures and y-o-y changes, but misses the important implications of the growth strategy underway in the value metrics of the firm. In fact, the growth strategy causing the reported GAAP numbers reinforces the case for both the investment thesis and fundamental value.
Fundamental Value metrics discussed in this article are defined here:
- ROIC (Return on Invested Capital) = NOPAT / Operating Capital
- 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). As an approximation FCF = CFO (Cash Flow from Operations) minus Depreciation and Amortization
- EV (Enterprise Value) = PV of prospective FCF
- Stock Value = (EV + Surplus Cash - Debt) / # Shares
The strategy of pressing the "pedal to the metal" to accelerate growth in revenues is 100% appropriate for ClickSoftware -- because of its outsized ROIC (over 100% in each of the last three fiscal years). Briefly, high ROIC results from a favorable industry structure, robust business model, and effective execution.
In my opinion, Q1 results y-o-y, lower gross profit margin, higher operating expenses, and lower EPS are the effects in the implementation of a necessary growth strategy.
Revenue acceleration is a highly welcomed and perhaps overdue event. The market should have celebrated the news as a precursor to greater shareholder value and higher stock prices. Instead, since early May, the price of the stock dropped some 30%.
Rapid growth in Q1 operating expenses including R&D (33% y-o-y to $11.9 million) will accelerate revenues and NOPAT. Growing revenues will increase shareholder value (EVA), even at the cost of a lower ROIC (see previously noted article). An expanded OC (and expenses to expand product, market, and sales capabilities) will produce greater EVA as long as ROIC > WACC.
Evidently Mr. Market is paying close attention to GAAP accounting, margins, and EPS; and giving little weight to ROIC and the impact of growth on enterprise value. Likewise, Mr. Market is not giving adequate consideration to the reinstated 2012 17% annual revenue growth guidance, or to management's track record on meeting and exceeding guidance.
Intact Investment Thesis
The investment thesis behind the business model and the growth strategy remains fully in force.
- Value Proposition -- Client benefit in the eyes of clients is evident. The roster of satisfied clients is growing, as is the size of market opportunity and foreseen geographic expansion (Latin America and Russia), and product suite expansion (Mobility and Cloud Access). Likewise the firm's position within the industry is strong (Gartner and Info-Tech rankings), and its competitive advantages difficult to replicate (Quality of Echo-System; Partners and Integrators). Various expansion initiatives are outlined in the recent investor presentation.
- Economic Returns - ROIC is exceptional (over 100% in each of the last three fiscal years). Strategies to emphasize accelerated growth are welcome and necessary. Business risk (operational risk and financial risk) is low; maintained within reasonable boundaries and in line with focused competence on workforce management and optimization and enterprise mobility.
- Management Competence - Management is stable, reliable, and with the proven ability to manage knowledge and organize skills, and to allocate resources and rapidly grow a business that delivers a sound Value Proposition and very attractive Economic Returns. Management is now appropriately emphasizing growth in the presence of strong ROIC.
As discussed in the previous article, the value of the stock is estimated at $13.00/share, based on $13.4 million in 2012 FCF, consistent with 2012 Outlook, growing at 9% per annum in for the following three fiscal years, and at 5% thereafter in perpetuity; WACC is 10% p.a. in 2012 and 9% thereafter.
The investment proposition for an individual investor is attractive based on the risk/reward trade-off defined below.
Risk is the likelihood that the current price of the stock will be unchanged (or lower) in the next 12 months.
Market expectations implicit in the current price of the stock ($8.80) can be defined as $9.30 million in 2012 FCF, growing at 6% in each of the following three fiscal years and 5% thereafter in perpetuity. WAAC is 10% in 2012 and 9% thereafter.
The likelihood of such depressed expectations continuing for an extended period of time is very low and is not borne out by historical performance. By way of reference, FCF averaged $11.51 million in the last two fiscal years, and grew at an average of 13% during the last five.
Reward is the appreciation in the price of the stock over the next 12 months; in the neighborhood of 40%+, assuming it reaches Fundamental Value. In my opinion the likelihood of the price of the stock raising to Fundamental Value (or in the neighborhood) is substantial (dividends are not included in the computation of reward).
The best news out of the Q1 2012 earnings report and conference call was the evident (implementation of the rapid revenue) growth strategy underway, and the reiteration of 2012 revenue guidance; 17% annual growth.
Execution of a growth strategy is welcomed news, given the firm's extraordinary ROIC. Corporate finance tells us that growth, given high ROIC, is mandatory for the benefit of shareholder value. An expansion in the number of career opportunities offered in the firm's homepage suggests that the runway for growth has ways to go.
Once again, Mr. Market provides investors with the opportunity of an attractive entry point at the current stock price.
Disclaimer: The material presented here is for informational purposes only. Nothing in this article should be taken as a solicitation 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 standards. 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.