Analysis: RightNow losses widen as business transition continues

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Second quarter losses have widened at RightNow as it rings in the changes - but Wall Street isn't impressed. CEO Greg Gianforte emphasises that while the short-term income statement impact is painful, the changes are unquestionably the right way forward.

By Stuart Lauchlan, news and analysis editor

RightNow’s continuing business model transition cost it dearly for its second quarter with losses widening and a frosty reception from Wall Street where the share price fell by 20 percent.

The company is shifting its business model away from perpetual licenses, a move which it warned investors would cause some pain while being executed. "The transition that we outlined earlier in the year is proceeding well, although it is taking longer than expected," admitted CEO Greg Gianforte.

That was the case with the second quarter when losses widened to $5.7 million from losses of $1.8 million in the prior year. Second-quarter revenue fell about 2 percent to $26.5 million, from $26.9 million in the second quarter of 2006.

The mix of revenue across geographies was 74 percent Americas, 19 percent EMEA, and 7 percent Asia Pac. Average deal size was approximately 164,000 compared to 211,000 in the first quarter and 123,000 last year – a 33 percent year-over-year increase in average deal size.

But the good news was seemingly overshadowed on Wall Street by the impact of the transition, which RightNow management insisted was the right course of action. “Last quarter, I detailed our plans to change some elements of the business model in order to reflect the current state of the on-demand market and to better align our financial statements with our business success,” said CFO Susan Carstensen. “At that time, we said, we would continue to offer perpetual licenses as an option to customers. And we forecasted revenue from those licenses while continuing to decline as a percentage of revenue but stay flat in total dollars.

"The transition that we outlined earlier in the year is proceeding well, although it is taking longer than expected." Greg Gianforte, CEO, RightNow

“We now know that the market is moving away from perpetual licenses, even faster than we had anticipated. We've seen it in our results and in our pipeline. To give you a good idea of how fast it is happening, compare the full year 2005 to 2006. While our bookings grew 50 percent and recurring revenue grew 38 percent, perpetual sales were flat. The trend was particularly evident in the fourth quarter as more and more customers selected the subscription option. We believe this is a direct result in the market's accelerated adoption of on demand especially among large enterprises. The perpetual mix adds an extra degree of risk and volatility to our results every quarter.

"Conversely, subscription revenue provides visibility, predictability, and allows for increased lifetime customer value. Therefore rather than fight the quarter-to-quarter volatility of a long transition, we have decided to jump right to the end and to eliminate perpetual revenue from the business model. We have taken perpetual licenses off our product price list. For those customers in our pipeline and our existing customers that prefer perpetual licenses, we will work to structure ratable arrangement.”

This has serious implications. “The immediate impact on the profit and loss is significant,” added Carstensen. “Our previous guidance for 2007 was for perpetual revenue of approximately $25 million. As we close those deals, we will pick up some revenue as it flows in throughout the year but given the five-year crossover point in the pricing, this adds roughly $2 million into revenue in 2007 versus the 25. The decrease in revenue essentially flows straight to the bottom line. This impacts Q1 the most but then the model immediately returns sequential revenue growth and profitability in 2008.”

Signs of success?

Nevertheless, Carstensen has insisted that there are still clear signs of success. “With these changes, the key metrics that drive the business are revenue, earnings and cash flow. Our success signing new customers, retaining our existing customers, and expanding those relationships will be evident in those figures. Visibility and predictability of our revenue stream will increase and earnings will be aligned with revenue.

"While the short-term income statement impact is somewhat painful for all of us, these changes are unquestionably the right thing to do for the business." Susan Carstensen, CFO, RightNow

“We believe the true sign of success in any business is the ability to generate cash. That has been a constant in our business model. And as we work through this transition in 2007, cash will be the clearest sign of success. We continue to expect to grow cash from operations approximately 30 percent in 2007. Many of you have asked that we provide some continued visibility on bookings especially during this transition period. The reality is that with the elimination of perpetuals, even the gross bookings number is not meaningful for year-over-year comparison. What is meaningful in comparable year-over-year is a measure of our new recurring business. The recurring revenue plus the change in net deferred revenue is a proxy for the new recurring business we are signing and billing.

"So, while the short-term income statement impact is somewhat painful for all of us, these changes are unquestionably the right thing to do for the business and for our shareholders, and now is the right time to do it. We are increasing the visibility and predictability of our business, increasing the lifetime value of the customer relationship, all while expecting to grow recurring revenue by 40 percent and cash from operations by 30 percent.”

Into the field

Gianforte continues to be upbeat about expectations for the company. “The next stage for us in terms of our vision is, how do we take this business from $100 million to $1 billion in revenue,” he said. “We've got to have the right people in place. It is critical for us that we pushed decision-making out away from headquarters into the field close to where the customers are. In particular that meant putting a General Manager in Europe to run Europe, to move our very successful public sector business, to put a person on the ground in Washington, DC. I personally think that has been an issue that we needed to address to continue to grow that business. So, I think we have a much stronger team today than we did six months ago. And honestly, I hope to have a much stronger team six months from now.”

There are also customer success stories to back him up, he insisted. “One customer story from the quarter that is worth sharing is Pearson Education,” he said. “We set up a pilot in their Boston office and were able to immediately reduce contact centre activity by 40 percent. Pearson Education was so impressed with what we did for them, they immediately became a reference account even before the pilot was completed. They have already asked to sit on a customer panel so they can share the success with others.This speaks volumes about the strong relationship we quickly forge with customers as a result of the rapid ROI we deliver.

"Traditional CRM has always been largely about internal processes and efficiency. Our success is driven by enabling our clients to focus externally." Greg Gianforte, CEO, RightNow

“Pearson also demonstrates the growing importance of customer experience. One macro trend that is getting a lot of airplay this year is the renewed focus on the consumer. Whether it's Time magazine naming YOU as the Person of the Year or the incredible success of the social sites like YouTube and MySpace, technology is connecting people with each other and connecting companies to their customers in far more intimate ways that were previously possible.

“This trend is having a profound effect on the distribution channel, which quite frankly is collapsing. Rather than deal with middlemen, consumers are going directly to manufacturers and suppliers for support. Consumers have been empowered like never before. And for companies, this demand for a direct relationship is quite daunting. Many of the most consumer-friendly companies have never had to deal directly with their end customers and aren't very good at talking to them or listening to them. Traditional CRM has always been largely about internal processes and efficiency. Our success is driven by enabling our clients to focus externally and actually reach through the channel and deliver more personal and relevant customer experiences without driving up costs.”

Let's talk 2007

All of this is having an impact on the focus for RightNow. “Customer experience is our focus in 2006 and this will continue in 2007,” explained Gianforte. “Our solutions enable our customers to actually talk to their customers, listen to their customers, and then respond to their needs. As proof, take a look at the awards our customers have won for outstanding experiences they are delivering using our solutions. TD Banknorth which ranked No. 1 for simplicity. Orbitz was named No. 1 for online customer respect. Overstock.com was recognised in the top five for customer service by the National Retail Federation. BT Global Services was awarded the Customer Service Innovation Award and Symantec was awarded for best practices in leveraging customer feedback.

“Our message here is simple. Companies who use RightNow set the standard for great customer experience. Let's talk about 2007. 2007 is all about leveraging our investment in RightNow 8 and expanding our success. We have been using the new product internally and several customers are already live. The response we have seen from these customers, industry analysts has been really fantastic.”

"While the changes in our financial model are the right thing to do for the business, they in no way change how we interact with customers or the value that we create for them." Greg Gianforte, CEO, RightNow

A crucial element is RightNow 8. “I believe RightNow 8 is a game-changing solution,” said Gianforte. “This may sound bold, but if you think about it, CRM is really broken into two camps. On one hand, you have the perception that you need in on-premise application for mission-critical deployments in order to deliver power and speed. That is how Oracle and SAP sell their vision. With RightNow 7, we pushed the browser to its limits and large enterprises became true believers. With RightNow 8, we eliminate any remaining barriers to mission-critical on-demand deployments in large enterprises.

“Our global sales team is very excited about the opportunity in front of us. We are giving them a game-changing solution to sell and they have the industry's most referenceable customer base to help drive their success. While the changes in our financial model are the right thing to do for the business, they in no way change how we interact with customers or the value that we create for them. This means we are in a better place than ever, and deliver solutions in line with our vision of better customer experiences at a lower operating cost.”

His overall conclusion? “Our focus for 2007 is simple,” said Giantforte. “One, we have aligned our financial model with the accelerating market adoption of on-demand. Two, we are continuing to penetrate large enterprises and expand within our install bases. And three, we are leveraging our investment in RightNow 8 to show our customers how to drive success by connecting directly with consumers.”

How willing Wall Street is to take this on board does of course remain to be seen…

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