Callidus in Difficult Transition

CALD is one of the major providers of Enterprise Incentive Management (EIM) software systems. EIM software helps large enterprises across many industries determine and automate total compensation packages.

Callidus' software assists customers on increasing productivity, improving profitability, and achieving a competitive advantage by effectively managing complex pay-for-performance programs.

However, many software firms are finding it difficult to close new customer deals. Part of the problem is the heightened level of cautiousness regarding IT spending among corporations. As a result, industry spending is focused on areas that are viewed as more strategic than EIM applications.

A substantial portion of the company's revenues comes from sales of products and services to customers in the financial and insurance industries. The recent slowdown in these industries has resulted in cancellation/deferral of planned expenditures by customers. Additionally, consolidations and business failures in these industries will substantially reduce the demand for the company's products and services.

We believe the company is undergoing a lengthy and difficult transition to an on-demand software subscription model, and operating results during this period could be inconsistent. Sentiment continues to be negative for software companies going through business mode shifts, although we think management has a good understanding of the current shifts in business model.

The company guided Q2 revenue to between $22 million and $24 million, and did not provide any specific EPS guidance. Q2 projected revenue at the mid-point is lower than our current expectation of $24.5 million.

Although it has made remarkable progress over the recent past, the company does not yet have a critical mass of subscription revenue (as a percent of total revenue) in order to be termed a subscription vendor. An important milestone for the company would be to generate at least 60% of its revenue from recurring revenue streams. It is probable that Callidus could achieve this by end-2009/early-2010.

If management continues to succeed in selling on-demand bookings, Callidus could potentially present an interesting investment opportunity in 2009/early-2010. As of now, we maintain our Hold on the stock, ahead of second-quarter results on Jul 28.

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