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Intuit's cloud transformation portends heavy weather ahead

Den Howlett Profile picture for user gonzodaddy August 21, 2014
Summary:
Intuit's cloud transformation continues, bringing mixed results in its final quarter. It plans to take a full hit on its business model next year as it anticipates an accelerated transition to subscription based services. What does this mean?

[sws_grey_box box_size="690"]SUMMARY: Intuit's cloud transformation continues, bringing mixed results in its final quarter. Those results, along with guidance into 2015 indicate Intuit plans to take a full hit on its business model next year as it anticipates an accelerated transition to subscription based services. [/sws_grey_box]

Intuit's Q4 was better than expected on the top line with revenue of $714 million but showed a loss of $73 million where analysts were expecting a modest profit. There were some one off impact costs but analysts were far from happy with this outcome and punished the stock in knee jerk after hours trading. But this belies the detail underpinning Intuit's cloud transformation strategy. Why should you care?

Market impact

Intuit's cloud transformation is important across multiple dimensions. First, as the world's largest accounting and finance related vendor for SMEs, what it does today impacts business tomorrow.

Second, we have learned that cloud transformation in the SME market usually runs 2-3 years ahead of similar changes in the enterprise market. That means we can reasonably say that while the mega vendors are on their own path, their big cloud transformations will occur in the 2016-17 time frame. This is important for buyers planning investments both now and into the near future.It also matters to SMEs right now.

Finally, the manner in which Intuit is going about its cloud transformation gives all the appearance of being predicated upon an extremely well defined and thought through strategy. Before heading  into that analysis though, we should push out some numbers to set the stage for understanding what happens next.

The numbers

From the forward looking statements in the earnings announcement:

  • Small Business revenue decline of 3 percent to 6 percent. Adjusting for the financial impact of the acceleration in QuickBooks Online growth and the changes in future desktop product offerings, Small Business revenue would grow approximately 10 percent.
    • QuickBooks Online subscriber growth of 35 percent to 39 percent.
  • Consumer Group revenue growth of 3 percent to 4 percent, which includes the financial impact of the changes to future Quicken desktop product offerings.
    • Within Consumer Group, Consumer Tax revenue growth of 5 percent to 7 percent.
  • Professional Tax revenue decline of 34 percent to 37 percent. Adjusting for the financial impact of the change in future desktop product offerings, ProTax revenue would grow approximately 5 percent.

intuit cloud transformation 2015 bridge
Intuit has used this earnings announcement as the point at which it goes all in on subscription accounting methods for software going forward, including the  application of subscription based pricing methods to its PC software sales that would usually be taken as an upfront revenue item. As you can see from the above illustration, Intuit is forecasting an overall fall in revenue for 2015. However, it is painting a much rosier picture on both the numbers of online subscribers going forward and the revenue impact over the next five years. (see image below)

intuit's cloud transformation

By 2017, Intuit believes it will have returned to higher total revenue 'approaching $6 billion' with 'predictable recurring revenue and generating roughly $5 in non-GAAP earnings per share.' That's ambitious and I'll explain why in a moment.

Turning to subscriber numbers, Intuit said on the earnings call:

QuickBooks Online subscribers grew 40%, up from 36% in the previous quarter. We added approximately 60,000 net customers in a seasonally slower quarter. We closed fiscal 2014 with nearly 700,000 QuickBooks Online customers and more than 1 million total QuickBooks subscribers. The new Online experience enables the seamless purchase of additional services as evidenced by our payroll attach rate improving to 19% in the fourth quarter, up from 16% a year ago. The attach rate for active payments customers is currently 5% also up from 3% in the prior year.

These are impressive stats and make Intuit by far the largest subscription based vendor in the SME market. They have clearly seen the risks posed by Xero's extraordinary success and acted accordingly. Soundings suggest they are scooping up disaffected Sage customers but quite what that impact looks like has yet to be determined. So how is Intuit planing to make the transition?

Intuit's cloud transformation strategy

On the call, the company said that it sees 2015 as the big year for transitioning, noting that it has been on a path towards fully subscriber based pricing for some time. Analysts were a tad skeptical believing that the QuickBooks customer base will take longer than a year to make that transition. The company recognizes this but believes that a combination of creative bundling and an exceptional user experience will win the day in what is a 'land and expand' strategy.

The reality is that for as long as Intuit can retain a lock on making tax filing a paying proposition, then that might well work. If competitors can come up with a better ot at least more cost effective solution for tax filing then Intuit might find itself having to rethink. In that regard I was surprised to hear:

...we get about $800 in annualized recurring revenue with QuickBooks Online today and it’s a little less than $500 on the Desktop. We have opportunities in both areas so look at different pricing strategies and different bundling strategies to help customers move to the cloud and we’ll talk more about that as we go down the road. But ultimately our ultimate goal was to make sure we’re delivering a good value for the price so the customer’s stays with us and does not chose another alternative and you will see that show up in some of the decisions that we’ll make in the coming months.

OK - so what does the customer gain other than a prettier interface? Well, it doesn't have to think about lost data or regular machine upgrades or backups and if that's deemed to be worth $300 pa then fine. If they get the various partner add-ons working well and seamlessly then yes, I'm hearing that tune resonate nicely. But...and it is always a big but...any time there is a change of this magnitude, it is an opportunity for fresh faces to turn up and upset the apple cart.

My take

Right now it is hard to see anyone making big inroads to Intuit's home turf. Their brand, product range, partner ecosystem changes and inbuilt maturity put them streets ahead of the only viable competition. But as Intuit already knows, these are early days and there is still a vast market to be captured. From the buyer's perspective, Intuit is starting to look more like the kind of subscription/cloud vendor it needs to be in order to take a credible place in that market.

From the investors perspective, I believe they did an excellent job on this earnings call in articulating what they've done, why they're taking next steps and what this means financially. Investment analysts might grumble now but they really need to start thinking differently if they are to ever properly understand this market. If the share dip is any indication then it ain't going to happen any time soon.

The only question mark in my mind is the extent to which the company will expand aggressively in other territories. That wasn't discussed on the call, neither were details on pricing. Those are questions for another day.

Finally, Intuit has firmly and finally validated the cloud model in unequivocable terms. It has all the piece parts in place so now it is about convincing those pesky SMEs that are wedded to the desktop solution that their cloud alternative really is the future.

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