ClickSoftware: Misguided Market Provides Opportunity To Fundamental Investors

On July 25, 2012 ClickSoftware Technologies (NASDAQ:CKSW) announced 2Q, 2012 Earnings. This article discusses the earnings report, the conference call, and mispricing of the stock. It also suggests the importance of management paying attention to fundamental investors, an important segment among market participants.

Q2 2012 Earnings Report and Conference Call

  • Revenues grew 9% year-over-year to $22.5 million. Excluded from this figure is a very large contract signed four days after the close of the quarter -a contract with Oi, Brazil's leading telecom, valued between $10 million and $15 million
  • Gross Profit declined 6% y-o-y to $12.7 million
  • Operating Income declined 97% to $90 thousand
  • Net Income declined 97% to $70 thousand
  • 2012 revenue guidance was revised to $98 to $103 million, representing about 13% to 18% growth over 2011; lower than the previously provided guidance in the range of $100 to $105 million.

Revenues increased y-o-y due to increases in the Americas (26% to $13.0 million), and in Asia Pacific (50% to $2.4 million), which more than offset weakness in EMEA (18% decrease to $7.1 million).

Decrease in Operating Income was principally due to (NYSE:A) lower Gross Profit ($0.8 million decrease) due to the higher proportion of lower-margin Professional Service revenues --required by the implementation of many large projects; and (NYSE:B) to higher Operating Expenses ($2.5 million increase) due to deliberate management actions designed to accelerate growth; expand product leadership and core expansion capacity.

Management actions supporting growth acceleration require increases in costs and investment. Below are highlights.

  • Expansion in the number of employees -by 60 employees, or 15%, to 465 employees since 12/31/2011
  • Substantial progress in enterprise mobility, a new growth engine. Currently there are 101 enterprise customers who purchased more than 130 thousand mobile user licenses, versus 60 thousand a year ago. This is 55% y-o-y growth.
  • Signing of the Oi contract. This contract is significant on three counts. First, it is one of the largest contracts signed by ClickSoftware in terms of revenues and employees served. Second, it is a substantial entry into the new South American market. Third, the client is a leading Brazilian telecom, with large and complex operations, requiring state of the art field service and enterprise mobility technology.

As in the case of Q1 results discussed in a previous article, Q2 y-o-y results -- lower gross profit margin, higher operating expenses, and lower EPS -reflect a deliberate strategy to accelerate growth. Such strategy is appropriate because of the company's outsized ROIC (over 100% in each of the last three fiscal years). The alternative; restraining investment and containing expenses to show good EPS numbers (and effectively dampen future growth), is not in the best interest of the shareholders.

Long term growth potential is sizeable. Dr. BenBassat, CEO, mentioned: "As a whole, demand in the workforce management and enterprise mobility market remains strong, as evidenced by the significant number of prospects in our pipeline expressing interest in our mobility offering. In particular, more than half of the opportunities generated in our pipeline during the second quarter contain our mobility solution. We are optimistic about our growth in the second half of 2012 and beyond."

In response to a question in the conference call the CEO responded that longer-term, the company should be able to grow at the historical rate if not higher, particularly taking into account new markets, such as South America and Russia, and new products, particularly enterprise mobility. The five year average growth revenue rate is 22%.

In my opinion ClickSoftware market and product opportunity is strong and growing. The growth strategy pursued by management is appropriate. The stock fundamental value of $13.0 /share is a good estimate.

Market Reaction

The market reaction, following the announcement of Q1 and Q2 results on April 2 and July 9, and the preannouncement of the Q2 on July 9, was negative. As an aggregate the announcements caused the price of the stock to tumble some 40% --from about $13.0 /share at the end of March to current level. Keep in mind that the revised 2012 revenue guidance, on occasion of the announcement of Q2 results, represented a minimal reduction over the original guidance, and still called for13% to 18% in annual growth.

Evidently the market did not appreciate the announcements, the guidance revision, or the decrease in y-o-y EPS. The growth strategy pursued by management did not get through.

It stands to reason that management confidence in communicating with the market is very important in realizing the fundamental value of the stock. Various passages in the earnings announcement and in the conference call paint management as being drawn by the Street analysts into the quarterly prediction guessing game. From a value perspective, discussion of the timing or the booking of specific transactions is not a fruitful exercise.

In the prepared remarks section of the Conference Call the CEO said "I normally do not go into fine details of our revenue composition plan for the rest of the year, but considering the uncertainty our investors feel these days I believe it is important to go into higher granularity so that you get the same comfort that we have. So here we are........"

It is not clear who "you" is. Maybe "you" are the analysts; or traders, who bet on short term price movement. I do not think that "you" would be the intrinsic investors, who understand strategic execution and know that earnings do not go up in a straight line.

The overriding focus of the Street on revenue accounting transaction detail, at the detriment of clarity on strategy-guided execution, is not effective investor communication. Implicit in the Street focus is preference for positioning increases in headcount, or slowing product development (expenses), or preference for booking low margin, last minute sales, to juice quarter-end revenues. These run contrary to sustainable shareholder value and have not supporting basis on value metrics. Management would do well in exercising the power of investor communications; channeling the information exchange into strategic execution.

Implicit in the ongoing Street discussion is neglect of fundamental value investors, who represent an important segment among market participants. They set value and pursue value realization over the medium and long term.

At this point, market players dominating the price action in the market are those who rely on other-than-fundamental information for short term profits (and informed investors who miss-value the stock, including those giving excessive weight to recent new information relative to robust historical metrics). It behooves management to engage intrinsic investors in the corporate discourse and to channel the discussion into areas relevant to fundamental value.

Management dismay over market reaction following the pre-announcement and Q1 results was palpable. In the Q&A portion of the conference call the CEO said that if the deal with Oi, would have come four days earlier, there would have been no pre-announcement and "everybody would have been much happier. So this deal by itself could have solved all the problems with the pre-announcement...... we know the way the rules of the game on Wall Street and we will continue to do our best to perform by the analyst estimates."

Value management suggests that management does well for shareholders by focusing on the implications of short term earnings on the long term performance of the company, instead of trying to meet the Street next month's expectations.

Beyond sounding unnecessarily apologetic, management statements do not portray clarity of purpose or confidence in managing for fundamental value.

The Market: Potentially a Good Partner

Warren Buffett makes an important point when he describes Mr. Market as a your good partner, provided you (the investor) are in the partnership for the good reasons. Below are excerpts from "The Essays of Warren Buffett: Lessons for Corporate America", by Lawrence A. Cunningham, Professor of Law, Yeshiva University.

" Even though the business that the two of you may own may have economic characteristics that are stable, Mr. Market's quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him."

" Mr. Market has another endearing characteristic: He doesn't mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you."

"But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren't certain that you understand and can value your business far better than Mr. Market you don't belong in the game. As they say in poker, " If you've been in the game 30 minutes and you don't know who the patsy is, you're the patsy."

Management, the Market, and the Opportunity

Management is doing very well in strategy and in business execution. Investing in growth is absolutely necessary in view of the company's high ROIC.

All important macro pieces are appropriately lined up for ClickSoftware --Market opportunity, industry leadership, product competitiveness, capacity to execute, and robust metrics --including high ROIC (capital efficiency), and rapid growth in free cash flow).

Management (and shareholders) can benefit from increased clarity in investor communication --to nurture and promote the realization of the firm's value in the marketplace; the convergence between value and price.

As it is, today, the net result is that the market is missing on the value discussion and on fundamental value of the stock; the disparity between value and price is too large. In my opinion, Mr. Market is too willing to sell the stock at bargain prices.

Disclosure: I am long CKSW.

Additional disclosure: 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.

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