Wednesday, June 2, 2010

Callidus Software Annual Meeting (2010)

Callidus Software (CALD) held its annual meeting in the heart of downtown San Jose. Around nine people attended the meeting, including only two non-employee shareholders. The company offered shareholders a small box of donuts, water, and coffee.

CEO Leslie Stretch handled most of the meeting telephonically, along with CFO Ron Fior, who was present in person. CEO Stretch has a delightful English accent, which was fun to hear. There was no presentation, so we went straight to Q&A after concluding the formal portion of the meeting.

A shareholder asked several questions, focusing on the company's top line growth. He asked, "What improvement in gross margins can we expect by the end of the year?" CFO Fior responded that he expected gradual improvement. Over time, he was hoping that some technological improvements, along with scale, would improve on-demand margins. [Note: page 10 of CALD's 10K states, "our overall gross margin declined from 43% to 39% from 2008 to 2009, and "revenue declined by 24%" during the same period.]

The same shareholder also asked how the company expected to get to "cash flow positive" or "break-even." CFO Fior answered that he expected a "gradual increase" in revenues and margins.

I asked about page 14 of the 10K, which shows a shift in Callidus' business model from consulting/professional services to on-demand. I asked why the company made the shift, especially when its own 10K stated that a "substantial portion of [its] revenues are derived from the performance of professional services." (See page 16, 10K)

CEO Stretch and CFO Fior responded that services revenue had been declining for years and switching from legacy licenses business to a recurring on-demand business model with much shorter implementation times resulted in much lower services revenues. For example, a legacy on-premises license might take a year to two years to implement whereas now, in the on-demand center, a new customer can be up and running in 3 to 6 months.

I then asked about the company's "wide moat." People looked confused, so I explained that a wide moat refers to something that protects a company from being conquered or beaten by competitors. For example, Oracle's software, once installed, becomes an integral part of a company's operations. In short, Oracle's wide moat is the "stickiness" of its software. CEO Stretch responded that "no one can do what we do for insurance companies," noting that Callidus' customers include some of the biggest insurance companies in the world, such as Allianz North American and Allstate. He also highlighted Callidus' "90% renewal rate," which indicates customer satisfaction and/or "stickiness."

I wanted to know more about the reasons Callidus' product is especially suited for insurance companies, so I sent a follow-up email. The company was kind enough to send me some of its thoughts: "Our product is especially suited to companies that have large distribution channels (agents), complex plans, and large data volumes from multiple data sources. It allows industries such as the telecom and insurance industries where these conditions exist to simplify the complexity through our rule-based engine and at the same time have flexibility to change quickly. We solve a difficult problem and make it easier for these companies to implement new incentive plans on a much more timely basis. With our acquisition of Actek, Callidus accounts for 2 of the 3 companies Gartner Research ranked positive in the insurance space."

On a side note, when I asked questions about the 10K, someone interrupted me, demanding my name and how I held my shares. At that time, this person hadn't asked the previous shareholder any of these questions, so I was caught off-guard. I repeated my name and disclosed the name of my brokerage. I asked if he was general counsel (i.e., a lawyer who is an employee of the company). It turns out that he was outside counsel (i.e., a lawyer who bills the company for legal services but is not an employee).

I always get concerned when outside counsel takes over meetings, even if only temporarily. First, the general counsel usually attends annual meetings (as in this case), so if there really is a problem, the general counsel can step in. Also, why pay an outside lawyer to sit at meetings when the corporation's own general counsel should be able to handle any legal issues that arise? To me, paying outside counsel to sit at annual meetings seems like a waste of money, but that's just me.

Second, anytime outside lawyers feel entitled enough to direct questions to shareholders, it tells you that the company may be placing too much trust and discretion in an outside law firm. Such faith can be an expensive proposition at 200 to 500 dollars an hour. Personally, I prefer to see strong CEOs and management and weak lawyers--not the other way around.

Third, outside lawyers have directed questions to me at meetings only at small companies where performance has lagged. Perhaps the company's inability to make the numbers emboldens the lawyers, who feel the need to assert themselves; however, successful businesses rarely do well when management is taking directions from lawyers. This is because lawyers tend to be risk-averse, and winning in the business world requires risk and gusto. (I can't help but remember the following words about Citigroup, spoken by its largest individual shareholder: "My recommendation and advice for them is they don't hire anyone unless this guy has expertise in banking. I told them, next time no lawyer, please." See here for more.)

In any case, here is my advice: to the extent a company or lawyer wants to know the names and status of shareholders at the meeting, it's really simple--just have a sign-in sheet outside the meeting room and have someone check the information on the sheet before admitting someone to the meeting. If you can't handle that basic protocol, the solution isn't to interrogate someone during the meeting itself. That's just basic common sense. What if I was a major shareholder?

[Update: the CFO wrote to me and apologized if I felt singled out. It turns out the other person asking questions at the meeting represented a major shareholder and was already well-known to the company.]

Callidus looks like an interesting company. I don't usually invest in software companies, but if you believe insurance companies are growing and will continue to need sales performance management software, you may want to take a look at Callidus.

Disclosure: as of June 1, 2010, I owned an insignificant number of CALD shares.

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