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Fast Financials: Three Day Old Fish Should Be Discounted

You may want to download the revised financials that are available today–May 30, 2008–on the Fast Search & Transfer Web site here. Information that I recall seeing on various Web sites is either no longer available or I lack the skills to locate the data. Mary-Jo Foley in her All about Microsoft Web log wrote a useful description of the implications of the deal when it was first announced. You can read this story here.

Some Fast Search corporate and general business information has been deleted because it was old or because it was deemed no longer of interest. Fortunately, I have a habit of downloading interesting documents when I first see them. Fast Search information is tough to locate using public Web sites for some reason. You can get these PDF documents directly from http://www.newsweb.no/index.jsp?messageId=209172. The explicit link from the Fast Search Web site with the pointer is here: http://www.fastsearch.com/news.aspx?m=329. Note: I am reluctant to post these documents because I am not certain of the Norwegian guidelines for this type of information.

A screen shot of the restated FY2007 data. I used this information plus the data in the FY2006 restated financials to make the table of numbers below.

A Walk Through

Fast Search’s top line revenues for the period from 2004 to 2007 are now reported as increasing from $66.4 million in 2004 to $143.0 million in 2007. That’s a jump of 115.4 percent. In the search engine game, the increase is good, but it does not match Google’s performance with its Google Search Appliance in the same period. Google went from zero revenue in 2004 to an estimate $400 million in the same period. (Note: that Google reported $188 million for its enterprise unit, but I have calculated monies from its educational initiative, maps, and partner contributions in the form of sign up fees, among other enterprise revenue flows.)

Nothing too dramatic in this run down except the sharp decrease in FY2006 numbers. But what’s $30 million in today’s loosey goosey financial world? However, when you look at the Fast Search restatements in terms of revenue, I found the losses interesting.

A Warning Signal from Fast Search

I have a copy of the Fast Search & Transfer Mid Quarter Presentation by Joseph J. Lacson, dated December 2006. That document has some optimistic comments about Fast Search’s opportunities. The presentation is no longer available on the Fast Search Web site, but I have made a couple of screen shots from the presentation to give you a sense of what caught my attention. (Since the document is no longer available on the Web, you may want to skip my discussion of this information. I wish I could provide a link to the full document, but I don’t have permission to do that. I wrote Fast Search’s PR department, but I haven’t heard anything from them.)

Here’s what I learned in Mr. Lacson’s presentation.

First, the presentation references a Goldman Sachs analysis about the importance of search. I have some experience with analysts in investment firms. It’s not surprising that there are such comments as “We believe the enterprise search market is going from ‘nice to have’ to ‘must have’ due to strong secular and regulatory drivers, similar to what happened in the business intelligence market three to four years ago’. (I’m not sure what’s happened in business intelligence, since that market is far from stable despite consolidation and shuffling.)

Second, the presentation included a remarkable diagram. It looks to me as if Fast Search’s analysts had determined that the market available to Fast Search is $4.8 billion. My own estimates peg the search market at about $2.8 billion in 2007. If we accept this $4.8 billion number, Fast Search had captured less than three percent of that market at the end of FY2006. Keep in mind that Fast Search asserts that it was in December 2006, the third fastest growing software company in the period from 2000 to 2005. Its growth rate of 85 percent lagged behind Google at 181 percent growth and Salesforce.com at its 124 percent growth rate. Mr. Lacson’s analysis put Fast Search in select company.

From Fast Search & Transfer Mid-Quarter, December 2006, by Joseph J. Lacson.

Third, the presentation stresses that Fast Search is investing in staff, retaining experienced sales people, and keeping key staff from taking other jobs. On the to-do list for 2007, Mr. Lacson identified investments of $4.0 million and some marketing activities. I interpreted this information to mean that Fast Search’s senior management team was paying attention to business. Okay, that’s what senior management teams are supposed to do.

Then, this statement caught my attention. Mr. Lacson’s presentation included this statement:

The company has instituted a policy of making a provision of five percent of outstanding end quarter accounts receivable for bad debts. In addition, some $3.0 million of receivables [are] under surveillance. No provision is required at present.

This information flashed a blip of warning lights. Mr. Lacson then stated:

Around year end 2005-2006 certain customers expressed an interest in paying M&S [maintenance and support fees] quarterly as opposed to up front payment.

Fourth, prior to December 2006, Fast Search billed customers for annual maintenance and support before the service was rendered. Some customers objected, and Fast Search decided to bill these customers every three months. There’s no problem with quarterly billing unless the customers don’t pay. MBA wizards call this DSO or days sales outstanding. If a customer pays a bill late, say, every 60 days, then you have to have enough cash to operate until that customer sends you his payment. With one late paying customer, there’s not much of a problem. When there are a significant number of late paying customers, a problem could grow and grow quickly. Now my warning lights are flashing a pulse of slow yellow lights. Mr. Lacson provided the following payment table.

From Fast Search & Transfer Mid-Quarter, December 2006, by Joseph J. Lacson.

In December 2006, I concluded that Fast Search had customers who were not paying their bills as much as a year late, not 30 days late. Why would customers not pay. I have worked in a couple of reasonably large corporations and over the years, I’ve worked for governments and for other consultants. In my experience, most bills are paid within 45 to 60 days. Any longer, there’s an invoice stuck in the bureaucracy or there is a problem. There’s no problem brewing. In my experience, there is a problem. If you sell software and the customer is not paying, then there is a problem with the software. If you sell service, as we did at Booz, Allen & Hamilton, there is a problem with the service. Mr. Lacson, without his knowing it, opened a nagging itch in my mind. Remember, we’re looking at a late-payment table from December 2006.

Fifth, there was some share buy back activity, a statement that revenue would come from Fast Search’s “organic core business”, and new business models, mergers and acquisitions. Routine stuff until Mr. Lacson noted:

FAST will be leading more project implementations (with partners as subcontractors) in 2007. Rationale for this is to ensure quality implementation of ESP [Fast Search’s Enterprise Search Platform Version] in key target markets, setting the stage for continued explosive future growth and new monetization opportunities. Projected impact is reduction in gross margin by five to six percentage points as cost of services increase.

Hmmm. Margins come down because Fast Search had to pay others to do the services work. If the company needs third-party firms to set up the ESP system, that suggests Fast Search itself lacks staff, or more accurately, staff with the know how to make the system sit up, beg, and roll over.

Without staff, companies licensing Fast Search ESP can’t get the system up and running themselves. The phrase “to ensure quality implementation” suggests that there must have been some non-quality implementations. Now the DSO table and its four month to one year “slow pays” made sense. To me, Fast Search sales professionals sold the product. The company booked the revenue and paid commissions. Then, the customers withheld payments to Fast Search because the software couldn’t be installed, customized, and maintained without engineers with highly-specific technical expertise. Google, meanwhile, was shipping the Google Search Appliance, essentially a search toaster. Mr. Lacson notes that in 2007, Fast Search would grown from 760 employees to about 10,000 employees and have more than 50 people “dedicated to new business models planned”. In short, get more people and start finding other ways to generate revenue.

Another Look at the Restated Financial Data

This table is based on the restated financials referenced in the first paragraph of this essay. These numbers are in thousands so a loss of $143,122 represents a loss of $143 million.

You can see that the profit and loss before taxes in FY2006 and FY2007 from the restated financials shows Fast Search dropping into the red in FY2006 and then increasing its loss to an intriguing $143,122,000. After the adjustments shown in the restated financials, the loss in FY 2006 seems to be about $30 million. And in FY2007 the loss jumped to $133,176 million.

What’s $1.2 Billion Buy

Microsoft paid $1.2 billion for Fast Search.

1. Software that doesn’t snag a decent chunk of the search market
2. Customers with varying appetites for the search system
3. Technology that will not narrow the widening gap between Microsoft and Google
4. Bureaucratic process if a police investigation gets underway. The financial regulators lacked the staff to do much poking around into what is now a problem for an American company.

There is the matter of paying $1.2 billion for a company with two consecutive years of operating at a loss. The analogy that came to mind is something my mother did when I was in grade school. We rode a bus to an auction. We paid to get into the auction. My mother bid on something that she thought was made of real gem stones. We rode the bus home. We discovered that the “real” gems were fake. We were out time, money, and the “real” gems.

Microsoft paid a significant amount of money for something that looked really good in the heat of the auction. In the bright light of the jewelry store, the value bleached away.

Observations

I don’t want to talk about Microsoft or Fast Search & Transfer. I want to make some observations about enterprise search. I anticipate some comments about this essay. I’m really not interested in the trials and tribulations of buyers and sellers.

First, this case example makes it clear that super-smart wizards don’t understand the complexities of search and retrieval. On the surface, indexing a document and matching the user’s query to an index is trivial. Well, if it were trivial, search wouldn’t be much of a problem. Search is not trivial. It remains one of the most complicated areas in computer science. An engineer with great confidence and a lofty IQ can crash and burn in the field.

Second, customers are looking for ways to address information access problems. When systems don’t work, some customers won’t pay their bills.

Third, customers don’t know what they want until a system is installed and operational. This makes life very difficult for vendors involved in content processing, search and retrieval, and text mining. If the customer doesn’t know what is needed, there is a continuing risk for vendors who make a sale. In short, it is expensive to keep customers happy.

Fourth, search is one part of the information access “problem”. Vendors who promise too much are playing a risky game. The cost of delivering a Star Trek type system are very high, probably infinitely high. The cost of making a Star Trek system actually work are equally high. No company has the resources to pay for Star Trek technology in our gasoline-powered world. Yet customers and vendors willingly connive to set themselves up for failure. I hate to invoke the “G” word but I will. Google’s search appliance works within specific limits. Simplicity has great value. The overly complex, hand crafted systems aren’t right for today business climate. The exception is the government because cost and value have different dimensions in that market.

Fifth, analysts don’t understand the exponentiating costs in search and retrieval. Without this knowledge, the whizzy MBAs can add up the numbers, but they can’t identify where the time bombs are buried. Presumably legions of bankers and business types looked at the Fast Search financial data and missed the warning signs. What other pitfalls lie in wait in search and retrieval?

To conclude, I think that the era of sprawling platform solutions in search is officially over. The companies with the opportunity to generate solid revenue and make customers happy are companies that have a product that can be installed, customized, and maintained by an average information technology professional. There are some systems that meet this criteria. I profiled 24 of them in my April 2008 study Beyond Search. Let me identify a handful of them for you: Coveo, Exalead, ISYS Search System, and Vivisimo. There are some specialists who can add functions to your existing system; for example, Siderean Software. There are providers of hosted solutions who can do the work for you at their data centers; for example, Blossom Software. Love it or hate it, Google delivers a search toaster that works as does Thunderstone.

I will monitor the information about Fast Search ESP and the other vendors in this market. One thing is certain–the Microsoft-Fast Search tie up makes a very interesting case study.

Stephen Arnold, May 30, 2008

Update: May 31, 2008. I heard from Fast Search & Transfer. The comment was “No comment”

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